The Stratalis Group | Change is Coming to The Diamond Market

The rough diamond market is facing a fundamental shift leading to opportunities and threats for all players within the value chain—with meaningful strategic implications.
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Diamonds may be forever, but diamond mines are not. The rough diamond market is facing a fundamental shift that could drive the price of diamonds to astronomical heights. This change will lead to opportunities and threats for all players within the value chain and especially for suppliers, with meaningful strategic implications.

For diamonds, with its tradition of complexity, the driver of this change is pretty mundane; straightforward commodity market supply and demand.

Strong Demand Meets Constrained Supply

Demand for diamonds has been strong and continues to grow in both traditional and emerging markets. The largest market, the United States, grew by 16 percent from 2012 to 2013 (Rappaport). However, as with all other commodities, the real opportunities lie within emerging markets, especially China. The world’s second largest diamond market has shown annual of growth of 8-10 percent (De Beers). With continued strong demand, the diamond market should grow an average of at least 4-6 percent annually.

Supply, meanwhile, is facing a cliff, due to aging mines and no significant discoveries in the last twenty years. There are very few new mines and the projects and production expansions that are coming on line are small. In fact many of today’s mines are facing production decreases as mines age and move underground. As a result, diamond production will likely be stable until 2020 and then start to decline.

We’ve Seen This Before

What makes this classic matchup of high demand and supply constraints interesting is how it mirrors a major commodity market situation. This is a case where the non-commodity diamonds market actually closely matches a true commodity; iron ore.

In 2002, the price of a ton of iron ore was about $29. As the Chinese market exploded, supply could not keep up with demand and the iron ore price increased nearly seven times, sometimes doubling year on year, until it reached $197 a ton at its peak in 2008.

Iron ore producers could easily increase production and today the price of iron ore has dropped to just 2.5 to 3 times what it was in 2002. Diamond producers cannot adjust production as easily. Diamonds supply will eventually increase with new discoveries, but the dearth of new projects in the short term coupled with the years long development process suggests that the diamond shortage, and hence tight market conditions, is likely to be a long one.

The Market Will Change

This has interesting strategic implications for miners and for the rest of the value chain.

Diamond producers today are following prudent price progressions strategies, increasing price by a few percent each year while they try to increase supply. Rough diamond prices have been increasing at a rate of anywhere from 6 percent to 14 percent a year (depending on who is reporting the numbers) and De Beers has recently announced their intent to raise prices 5 percent a year. Looking at this from another perspective, with a diamond market as tight as the iron ore market was, producers have the opportunity to increase rough diamond prices significantly, 6-fold or more.

Diamond producers are also stretching production. Despite increasing prices, this is diminishing the investment value as it drives up mining costs. With prices increasing over time, producers have the option to slow down production and focus on mining efficiency over maximizing carats. Driving costs down would increase profitability today while maintaining or increasing the value of reserves in the ground over time.

With higher prices the threat of substitutions to traditional diamonds will increase. Higher prices will drive consumers to put their money into other luxury items. At the lower end of the scale, this could increase the attractiveness to consumers of “new luxuries” like iPads over diamonds. Although with a 2-3 fold increase in retail prices, mainstream jewelry may find itself competing with luxury cars and even houses.

iPad’s, however, are unlikely to be acceptable engagement tokens anytime soon. What is likely, given the strong drive for diamond engagement rings and other jewelry is that consumers will substitute for lower quality stones. This will drive up the value of smaller, browner, more included stones further benefiting producers. Diamond producers have a history of successful marketing and could again invest in marketing diamonds as a whole and specifically lower-quality stones, maintaining brand equity and reducing substitution threats.

Substitution away from diamonds will happen, but this can be managed. More likely than substitutes would be diamonds entering the market through an increase in secondary markets and an incentive for greater competition from manmade stones. Neither market is significant at the moment but higher prices could easily drive demand for both. Here again, branding and marketing are key. Investing in branding that reinforces the distinction and allure of natural vs. manmade and new vs. recycled diamonds will ensure space for everyone and perhaps even grow the market. These diamond alternatives could fulfill the lower-end consumer need while fueling the aspiration to bigger, whiter, more natural stones.

Rough price increases will also create investment opportunities through changes in the value chain. Cutting and polishing will be squeezed, driving consolidation and possibly eliminating some of the intermediate, non-value adding, steps. Jewelers will face the dual challenges of securing supply and raising prices to the customer. Producers may need to invest in cutting and polishing, diamond manufacture or even retail. This could lead to a different sales process. We could even see a market traded diamond fund.

How Diamond Producers Should React

There are four strategic pillars to maximizing value and balancing risk for diamond producers:

Create efficient mines: Slowing down the mines and investing in innovation that drives out cost rather than maximizing production will yield immediate profitability benefits, increase reserve value and ensure longevity.

Increase prices aggressively: There is an opportunity to significantly increase long-term prices in a tight market to solve the supply / demand gap and drive value.

Understand scenarios and create options: Producers must understand potential positive and negative disruptions, such as those from secondary markets, manmade diamonds and others. This type of scenario thinking will lead to strategic options allowing producers to find new sources of value, mitigate risks and invest where it makes sense.

Invest in branding: As in the past, producers will need to differentiate their product and create demand for all diamond grades to both grow the market and stave off competitive threats from inside and outside the industry.

The rest of the value chain will not have the same options as producers, however they must apply the same thinking; understanding strategic scenarios to create options, improving efficiency and investing in branding and differentiation to discover opportunity within their markets and survive.

The scarcity of diamonds finally reflects their branding. This is a huge opportunity for producers to profit. Raising prices, however, will change the market and result in winners and losers throughout the value chain. The victors will be those with a clear strategy to take advantage of change and ensure that the profitability of a diamond outlasts the mine from which it came.

Originally published in Mining Global Magazine, October 2014