Friday, April 6, 2012

Diamonds on the block - anybody buying?

The diamond world now feels otherworldly.  We got a big hint when the Oppenheimer family decided to sell out, then BHP starts looking to sell their mining operations, and now Rio Tinto jumps in as well.  As a major supplier, Russia holds out.  Does anyone think that we are seeing "business as usual?"

A few added points.  Rio Tinto's plan to go underground at the Argyle mine has incurred big overruns. BHP's Ekati mine (its only one) is declining in output.  Both companies see little future in diamonds, and present output contributes little to their overall profits.  De Beers (now an Anglo-American branch, in essence), in its current round of selecting sightholders, has opened the door much wider for tenders and allowing others to buy diamonds.  Then, on Rapaport's reports, we see that about 900,000 diamonds, worth about $6 billion, are listed for sale.  And these diamonds average just over one carat in size.  That alone is enough for every bridal store in the US to sell a carat+ diamond a week for the next two years.  Never mind the huge stocks that are not listed on Rap.

These facts do not all pull in the same direction.  Mining companies may see growing demand, but finding and developing new mines has become very difficult and expensive.  In addition, the outlook for diamond mining ever being an important part of major mining companies' business is about nil.  Smaller, dedicated entities, and artisanal mining will continue.  The center of gravity will shift to those holding stocks - the major cutters and dealers in the world.  The disorganized entrepreneurial nature of that sector of the market is enough to drive miners out of the business.  Big stock holders, almost all family run, tend to act and react in personal ways, which are often unrelated to mid-term and long-term business sense.  That makes for a dangerous environment for any sizable mining company.  Rio Tinto, for example, at the Argyle mine, has now invested well over $1 billion in going underground.  That kind of money seeks some degree of stability and long-term continuity, which are not the outstanding characteristics of the business.

The issue is further complicated by market uncertainty in small goods, the bulk of run of mine productions.  Jewelry production relies heavily on diamonds from 3 points and down, these days even more so on 1 pointers and down, and there has been great reluctance to expand production in that range. This has been the bedrock of Indian manufacturing for many decades, and over most of that time a healthy cash cow.  Not so any more.  Pressure on margins have steadily increased over the years as retailers grew in size and power and were able to exert leverage in a market with excess capacity and supply.  That changed significantly with the Great Recession, which capped a period of declining production, factory closings, and rising labor costs.  Major dealers now farm out a good deal of production, and factory owners are reluctant to add capacity unless prices rise.  Which they have been doing, driven in part by the very same lack of capacity.

Even then, everyone is still focused on the global economy.  There is no need here to cover the Euro problems, a struggling recovery in the US, and growing concerns about the Chinese, Indian and Brazilian economies.  So how does one justify the expense, and risks, of opening factories? 

On balance, the decisions by the major mining companies to get out makes perfect sense.  And Anglo-owned De Beers is moving as quickly as possible towards a revision of their business model to make that business as salable as possible.  Now the only question is - who will want to buy these operations?