The Credit Driver at Work

During De Beers’ Sight last week, the company raised prices by 2-4% on average, according to traders. Sightholders that chose to sell rough diamonds from the Sight reportedly sold them for higher premiums. Premiums on 4 grainers (1 carat rough diamonds) and larger are up to a reported 8%-15%. Some goods are selling for list price, or up to 3% above list price. With few exceptions, the rough diamond market is generally strong - some even described it as “hot”. The exceptions are boxes of -7 rough diamonds and the cheap goods, which are hard, if not impossible, to move. Considering that consumer demand for polished diamonds is not rising, we are faced with a mystery: what is fueling demand for rough diamonds?  

With few exceptions, the rough diamond market is generally strong - some even described it as “hot”. The exceptions are boxes of -7 rough diamonds and the cheap goods, which are hard, if not impossible, to move. Considering that consumer demand for polished diamonds is not rising, we are faced with a mystery: what is fueling demand for rough diamonds?

Polished diamond inventories are not decreasing, which means that adding to them, by buying and polishing rough diamonds, does not make economic sense. Further, it seems that demand in the market for polished diamonds is steady at best, and prices for most categories are shrinking. There are, however, some areas with demand, enough even to lift some prices; 0.30 – 0.50 carat rounds, for example. But is that enough to create the recent rush for rough diamonds?

Another possible reason is preparations for Diwali, a holiday celebrated in India during which many businesses are closed for several weeks. Last week I spoke of the different drivers that fuel demand for rough . One of them is the factory driver. To recap, the push comes from the need to keep the systems and employees busy. Laying off workers is very costly in both the short run and the long run because of the cost of training.

Due to the decline in demand, manufacturers cut back on factory staff work hours. The idea is that everyone comes to work every day, and everyone is busy, but by reducing work hours, manufacturers can still reduce output. But as Diwali approaches, many workers want to increase daily work hours, so they can save up before going home for the holiday.

Some manufacturers say they are buying more rough diamonds to pick up the pace at the factories before Diwali. This may be with the intention of shipping the goods to other diamond trading centers that are working during the period, and have goods available for buyers. In addition to this, the larger polished diamonds, 0.30 to 1 carats, are still needed for setting in jewelry for the November-December holiday period. The smaller goods take longer to set and therefore should have been mostly delivered to the jewelry manufacturing companies. The larger goods are also shipped directly to stores loose, also for the holiday season, so polishing these goods is taking place now for October-November delivery.

The financing driver

If demand and inventories are steady, why the rush for rough by the larger players? The answer lies partially with the smaller manufacturers. They don’t have much inventory and need goods to work. From the standpoint of a firsthand buyer, this is a great opportunity.

As stated last week, the ability to generate profit on the trade in rough diamonds is a key driver to buying rough diamonds in the first place. The main diamond miners directly supply a limited number of manufacturers. Almost everyone else depends on secondhand supply. The trade in rough diamonds between firsthand buyers and the secondary market can at times be lucrative, generating large premiums for the sellers, and right now there are some areas with double-digit premiums.

At the same time, many buy and sell at the same price. Where is the benefit in that? If a buyer can’t pay on the spot and asks to pay in 30, 60 or even 90 days, the price of the goods rises accordingly, and it seems that sellers charge extra for credit. They are financing the transaction for interest.

This credit may carry an interest of 1% per month, a very profitable return on the money. However, the recent decline in business, together with the concern over companies’ vitality, led to a decrease of the interest to 0.5-0.6% per month. Today transactions may carry a much higher interest rate – some 1.25% per month.

This raises another question: why is interest higher than the usual 1%? The main reason is a shortage in cash, a liquidity crunch. Because limited liquidity is pushing up the cost of borrowing, the cost of money is high.

In a nutshell, this is the story of the diamond pipeline’s midstream today. Consumer demand from the wholesale sector is subdued, and polished diamond inventory levels are steady. Despite this, the pace of manufacturing is rising in India, demand for rough diamonds is therefore rising, pushing up its price, and many of the buyers simply don’t have the capital on hand to buy the higher-priced rough diamonds.

The main driver for buying a raw material is to manufacture a product for profit. That does not seem to be the case this past week, which once again raises a question: where do we head from here? Have we missed the opportunity to turn the market around, and instead settled for short-term gains that may result in long-term damage?

The views expressed here are solely those of the author in his private capacity. No one should act upon any opinion or information in this website without consulting a professional qualified adviser.