It seems that diamonds, contrary to what Ian Fleming had to say, are not forever. Last month,
The move mirrors a review that was set in motion in November by industry rival
Another option exists for both Rio Tinto and BHP, according to Nomura. The Japanese investment house floated the idea of merging the separate diamond businesses into a new company and floating it on the stock exchange. Nomura believes that the newly merged entity – with an estimated market value of $2.1bn-$3.5bn – would be "the largest listed diamond company with a solid asset base and lower overall sovereign risk". This scenario moved a step closer as reports have emerged that US private equity giant KKR is considering undertaking such a scheme. KKR has also been linked to a possible deal for Ekati.
At first glance, it's hard to fathom why Rio Tinto and BHP should wish to offload their diamond interests anyway, particularly given recent price performance – rough diamond prices rose by 24 per cent during 2011, after recording 32 per cent gains in the two preceding years. The simple truth, however, is that diamond interests of the two mining heavyweights are peripheral to their global mining operations – accounting for less than 2 per cent of forecast cash profits for 2012. It's been the long-stated aim of both companies to achieve market-leading positions through scale, but neither miner was ever going to establish primacy in the manner of Cecil Rhodes' De Beers.
Of course, fellow FTSE 100 constituent
Anglo's decision to increase its exposure to this segment of the mining industry is supported by pricing fundamentals. A report compiled by consultants Bain & Co for the Antwerp World Diamond Centre highlights factors that are likely to underpin rough diamond prices for the foreseeable future. Bain makes the point that "no major discoveries have taken place in the past 20 years", and even in the unlikely event that a significant new source was identified in the near term, the lead times associated with a large-scale development would stretch well into the next decade.
Prices could conceivably be undermined through the successful development – and subsequent market acceptance – of synthetic gem quality diamonds that could compete with the natural product from a price perspective. Ninety five per cent of industrial grade diamonds are now produced artificially, but the production of high-quality stones is currently cost-prohibitive and is likely to remain so for some time to come. "In the next decade, demand for rough diamonds is set to outpace supply under all considered scenarios," states the Bain report.
Of course, demand for precious gemstones and diamonds is predominantly tied to the $156bn annual trade in fine jewellery. This segment of the global luxury goods market has grown substantially since the mid-1990s due to new demand from a rapidly expanding bourgeoisie within the world's emerging market economies. The market supporting the diamond trade is forecast to grow at 6 per cent annually through to 2020, driven largely by consumer demand for upmarket goods in both China and India. The proportion of the overall market attributable to these economies has increased four-fold since 1999, and their influence will soon bear comparison to that of the US.
The new gold?
However, there's another potential price lever worth considering. Demand for gemstones within China could rocket if consumers start buying stones from an investment angle, in much the same way as they do for gold. It's been well documented that the ability of China's middle class to protect their wealth is being stymied by a shortage of viable financial instruments. And, of course, this situation was exacerbated after Beijing – somewhat belatedly – put the kibosh on property speculation. Therefore, it's possible that diamond prices, like those for gold, could be driven upwards due to a clamour for physical assets, particularly if inflation takes hold again in China, or if Beijing's expansionist monetary policies do eventually degrade the yuan. The growing incidence of auctions within the gemstone markets could accelerate this process, but the main hindrance to the establishment of a genuine investment market is the absence of a spot pricing mechanism.
It's worth noting that other parts of the world have increased their share of diamond sales within the global market, over traditional centres such as Antwerp and New York. Dubai, for example, is taking steps to gain a foothold. In 2004, the Dubai Diamond Exchange was established – a subsidiary of its central commodities authority, the DMCC. At that point, the Emirate's annual trade in diamonds was worth around $3m, but this had surged to $35bn by 2010.
Despite Anglo's controlling stake in De Beers, it's obvious that the integrated conglomerates are not expanding their diamond operations. Relative to the returns they can expect from their bulk mining operations, the segment is small-fry, while the likes of De Beers and ALROSA – Russia's premier producer – are either subsumed as part of a larger organisation or government-owned. So UK investors looking to profit from forecast gains in the price of diamonds will probably need to turn to the junior end of the market (see our 'Favourites' below) . Certainly, the market fundamentals are increasingly moving in the producers' favour – if only someone could establish a transparent marketplace.
by Des Kilalea, mining analyst at RBC Capital Markets Europe
In the resources space there are few products with as encouraging a price outlook as rough diamonds. While adding meaningful production in sectors such as copper is challenging, in diamonds the main impediment to growth in output is the scarcity of ore bodies, which justify mining and limited exploration spending. At the same time, demand for diamonds in jewellery is growing, not only in the burgeoning Asian markets, but also in developed countries such as the US.
Since the first kimberlite pipe (the primary host rock for diamonds) was discovered in South Africa near the town of Kimberley in 1871, some 6,000 pipes have been examined and less than 1 per cent were economic to mine. Many of those mines are now exhausted and even with new production from the handful of pipes which could become mines, global production promises to be flat, at best, over the next decade. The mines which we expect to come into production include Lucara's Karowe (Botswana), Stornoway's Renard and De Beers/Mountain Province's Gahcho Kue (Canada), Firestone's Liqhobong (Lesotho), DiamondCorp's Lace (South Africa) and a new mine in Russia (Grib). Even with those mines ramping up production, our forecast is for production to begin to decline from around 2014-15.
More than 95 per cent of all diamonds by value are used in the jewellery sector (the balance goes to industrial uses). At present about 40 per cent of all diamond jewellery is sold in the US, with China being the world's second-largest market. China is growing strongly (double digits), as is India, as the trend to use diamond engagement rings increases and wealth leads to rising purchases of luxury goods. The conclusion we come to is that demand growth will outstrip supply and this will lead to strong rough diamond prices once the world returns to the growth track.