Winter production shutdown cancelled at Diavik

Improving market conditions and rising diamond prices mean that Harry Winston (HW-T, HWD-N) will not proceed with a planned six-week winter shutdown at its Diavik mine in Canada’s Northwest Territories.

The economic downturn had forced the company to curtail production and shut the mine down during the summer before reopening it on Aug. 24, and it was going to shut it down again from Dec. 1 through Jan. 11. (Prices for rough diamonds in the first quarter were at their lowest level since the Diavik mine began operation.)

But the outlook for diamonds is starting to look brighter and management has had a change of heart. “We do not foresee a return to extreme conditions that would warrant a further shutdown,” Robert Gannicott, Harry Winston’s chairman and chief executive, said in a statement on Sept. 15.

Harry Winston owns 40% of the mine, while London-based Rio Tinto (RTP-N, RIO-L) is the operator and controls the remainder.

Rio Tinto raised the prices of its Diavik diamonds by 15% in September, according to Bloomberg. “We’re seeing demand start to pick up,” the news agency quoted Rio Tinto’s Bret Clayton, as saying. Clayton is Rio Tinto’s chief executive officer for diamonds, copper, and nickel. “The supply chain is now destocked so we are starting to see some pull-through in demand for diamonds.”

In a press release outlining Harry Winston’s second quarter results, Gannicott noted that the rough diamond market had continued “to build momentum” from the end of the first quarter. “Rough diamond prices increased substantially during the quarter with our own pricing ending at 50% above the low point in the first quarter,” he stated.

“Polished diamond demand continued to be resilient in the Far East and a cautious but definite return of interest from U.S. buyers has helped to revive the industry,” he added. “Diamond polishers have been eager to purchase rough diamonds, which are still restricted in supply, leading to firmer prices in the quarter.”

Kinross Gold (K-T, KGC-N) is one company that sensed that the diamond market might be on the verge of a turnaround and made a strategic investment in Harry Winston in March that has paid off handsomely.

The gold producer’s investment consisted of two parts. The first component was a subscription for a minority 22.5% interest in the partnership that holds Harry Winston’s 40% interest in the Diavik joint venture. The net effective subscription price was US$104.4 million.

The second component was an equity private placement of 15.2 million shares of Harry Winston at a price of US$3 per share, for a total investment of US$45.6 million, giving Kinross a 19.9% interest in the diamond miner and retailer.

Since then Harry Winston shares on the New York Stock Exchange have soared to US$9.26 apiece – handing Kinross a gain of about US$285 million. (Over the last twelve months Harry Winston shares have been trading between a low of US$1.69 per share and a high of US$10.75 per share.)

“We believe that, as with gold, the long-term supply and demand fundamentals for high-quality diamonds are strong,” Kinross president and chief executive Tye Burt said in a statement at the time of the investment. “Harry Winston occupies a unique and respected place in the global diamond business.”

In addition to the investment, Kinross’ executive vice president and chief financial officer, Thomas Boehlert, joined join Harry Winston’s board of directors.

Despite posting a net loss of US$24.5 million or 32¢ a share in the quarter ended July 31, (due in part to net foreign exchange losses on future income tax liabilities), and the fact that consolidated sales slipped to US$94.8 million from US$186.1 million in the same quarter a year ago (resulting in a 75% decrease in gross margin and a loss from operations of US$3.9 million), Harry Winston’s Gannicott said he was confident the diamond market was improving.

“Although retail sales remained below profitable levels [in Q2], we have seen a 9% increase in transactions worldwide compared to the prior quarter led by increases in the Far East, including Japan,” Gannicott said on Sept. 10. “Sales have also edged up month to month during the quarter suggesting a shift in momentum.”

This year Harry Winston expects that about 1.3 million tonnes of open pit ore will be mined, the majority of which will come from the A-418 kimberlite pipe, with the remaining production coming from the A-154 south open pit. Total carat production is forecast to be between 5 and 6 million carats on a 100% basis. It expects Diavik could deliver about 7.5 million carats in 2010.

Currently an open pit mine, underground production at Diavik is expected to start in early 2010. Open pit mining will end in 2012.