Diamond glut ‘not as catastrophic’ as people believe: Lucara CEO

After a decent 7% increase in 2014, rough diamond prices have fallen for the past year, prompting diamond equities to follow.

Pureplay Dominion Diamond (TSX: DDC; NYSE: DDC), for example, is down 42% over the last year.

While De Beers CEO Philippe Mellier predicted this March that rough prices had bottomed after softening at the end of last year, and that the second half of 2015 would be stronger, prices have continued to fall, Lucara Diamond (TSX: LUC; US-OTC: LUCRF) CEO William Lamb says.

“I don’t think he could have been more wrong,” Lamb says, noting that most producers have seen prices fall 15–20%.

“My estimate is De Beers would normally sell $3 billion in the second half of the year — and if they make $800 million, it’s going to be a good year for them.”

But the weak prices don’t extend to all parts of the market, Lamb says.

“Alrosa, De Beers — even Dominion Diamond — have only sold their larger, coarser stones because there’s no market for the smaller stones of poorer quality,” Lamb says.

Fortunately for Lucara — which in November recovered the second-largest diamond in history from its Karowe mine in Botswana — the market for larger diamonds remains strong.

While 25–30% of Lucara’s revenue comes from smaller, lower-quality goods, Karowe is a reliable source for exceptional, high-value diamonds.

“About 70% of our production is sold into an area of the pipeline where things are still moving through. There’s no glut in those larger, special stones.”

De Beers has reacted to the oversupply in the small- and medium-sized categories by cutting production back to 29 million carats, from 32–34 million projected at the start of 2015. But Russia’s Alrosa, the world’s largest producer by volume, increased production 16% in the first nine months of the year.

“The ruble has decreased in value by 60% over the last year and a half, so they’re going: ‘Hey, it doesn’t make any difference to us. We can just pump the carats out because our operating costs are half of what they used to be in U.S. dollar terms,’” Lamb says.

Cutters and polishers have also added to supply by polishing two stones out of small diamonds that used to yield only one polished stone, thereby “maximizing the value of the rough,” Lamb says.

“The volume of polished they get from the same amount of rough has increased as well, which has just added to the problem of the increase in polished inventory.”

Slow economic growth in China has affected demand, as has the strength of the U.S. dollar, which has made diamonds more expensive for most of the world. Adding to the diamond sector’s problems is a lack of liquidity, with banks less willing to extend credit to diamond-cutters and polishers.

Diamonds and luxury goods once placed high on the list of what consumers would do with their discretionary spending, but they’ve been replaced by experiences, like travel and gourmet dining.

This affects lower-quality goods, rather than the high end of the market.

“Instead of buying the Walmart-type goods, the smaller clusters of finer diamonds … the consumer’s not buying diamonds anymore.”

In its third-quarter results, Lucara forecast a “prolonged weakness in smaller lower-quality goods,” due to high inventories and oversupply in these categories.

Lamb says there is anywhere from one and a half to two years of polished inventory in the smaller size  categories.

But this isn’t as bad as it sounds: a comfortable level of inventory is one year.

“Our estimate is that between Alrosa, De Beers and Dominion — the big three — they must now hold $5-billion worth of inventory,” Lamb explains. “People say: ‘Oh, that’s an enormous number!’ but it’s only three to four months’ worth of production, so it’s not as catastrophic as what a lot of people believe.”

However, some effort is important on the marketing side to get diamonds moving.

“I don’t think it will take much marketing to see a lot of those goods flow into consumers’ hands. It’s going to be interesting to see how effective the marketing is that will happen over Christmas and the Chinese New Year … how much it will affect the market.”

There could be a slight increase in diamond prices in the first quarter of 2016, depending on whether there is a quick outflow of goods through the pipeline over the holidays. But if marketing efforts are not sustained, Lamb says prices could drop again near year-end, as the pipeline slows and liquidity dries up.

“Until we see the sustainable movement of the pipeline, it’s just going to be this cyclic event of good and bad news all the time,” he says.

That’s where marketing comes in.

“Generic marketing has slowed down, so diamonds are not on the forefront of people’s minds anymore, and therefore they default into [buying] these other things,” he says.

Recognizing the need for generic marketing, De Beers announced in August that it would launch a generic campaign targeting men in the U.S.and China that are looking for gifts for their partners over the holiday season.

“It’s really targeting those people that will be spending up to $1,000 on a piece of jewellery, where that money’s now flowing somewhere else,” Lamb explains. “How do we bring that money back to buying diamonds? Only when that happens will you start to see polished flowing out of the pipeline, liquidity, buying of rough and a clearing out of the entire pipeline. Otherwise we’ve got this glut in two areas — polished and rough, which is not good.”

De Beers stopped spending on generic marketing years ago to focus its advertising on its Forevermark brand.

The Diamond Producers Association (DPA), formed in May by Rio Tinto, De Beers, Alrosa, Dominion Diamond, Lucara Diamond, Petra Diamonds and Gem Diamonds, announced the appointment of ex-World Gold Council and De Beers marketing expert Sally Morrison as managing director of marketing in October. Jean-Marc Lieberherr of Rio Tinto has been named as chairman of the association, while Stephen Lussier of De Beers was named vice-chair.

“The DPA is moving forward and putting things in place — that’s encouraging for the market, and even the polishers and the cutters, etc., are quite excited about it, because it is now a formalized process where the diamond companies are going to support it … driven by a consolidated effort of the industry itself.”

The association will grade the effectiveness of De Beers’ generic campaign over the holidays, and look to put its own campaign together in 2016, with the help of ad agency Mother New York.

Lucara’s 1,111-carat stone

Lamb doesn’t know how much the 1,111-carat diamond recently mined at Karowe is worth, but says that Lucara — which is debt free and had US$123 million in cash at the end of October — is in no hurry to sell it. To get the best price, it will not be sold along with other high-value diamonds in the firm’s regular special tenders, but on its own.

While the stone has garnered a lot of media attention as the largest diamond ever recovered in Botswana, and the second largest-diamond recovered since the 3,106-carat Cullinan stone in 1905, Lamb says an underappreciated part of the story is the technology that recovered the treasure.

Lucara recently installed several XRT machines at its processing plant in Karowe that replace dense media separation processing in the coarser size fractions: 8 to 14 mm, 14 to 32 mm and 32 to 70 mm.

“Never has a 1,000-carat dia
mond been recovered by a processing facility,” Lamb says, noting that the largest until now was a 603-carat diamond from the Letseng mine in Lesotho.

If the 1,111-carat diamond had been processed before the plant upgrade, it would have been broken, Lamb notes, as the top size the plant could process was 35 mm. The historic stone measures 66 by 56 by 40 mm.

Knowing that the plant upgrade would be completed in mid-2015, Lucara had stockpiled a lot of the material it had recently mined from the South Lobe at Karowe, the source of the operation’s exceptional stones.

Since the 1,111 stone, the company has also recovered 813-carat and 374-carat stones.

Lucara forecasts revenue of US$200 to US$220 million for 2015, on sales of 350,000 to 400,000 carats.