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Rising demand for diamonds from Asia and the US could soon meet a supply shortfall
June 5, 2013

Epochal change is afoot in the murky world of diamond mining. For over a century, the famed De Beers conglomerate ruled the world's diamond trade with an iron grip, controlling production and monopolising sales channels. But over the last few decades, a handful of genuine competitors eventually emerged to create a new regime run by the so-called 'Big Four' - De Beers, Russia's Alrosa, Rio Tinto (RIO) and BHP Billiton (BLT) - which together accounted for as much as 90 per cent of all rough diamond production. Now, that's all set to change.

No more Big Four

Both BHP and Rio put their ageing diamond businesses up for sale a year ago, as surging profits in their iron ore and coal divisions ensured revenues derived from diamond mining were little more than rounding errors in annual financial reports. BHP sold its Ekati mine to Canada’s Dominion Diamond Corp (CA: HW), formerly Harry Winston Diamond Corp, in April for $553m (£365m). Rio hasn't been able to find the right price for its assets yet and there are reports that Morgan Stanley has been hired to oversee an initial public offering (IPO) in London.

Russia's state-backed diamond major, Alrosa, has IPO plans of its own. Chiefs have confirmed 14 per cent of the business, currently 91 per cent-owned by the government and with a tiny free float, will be listed in Moscow late October or early November. Alrosa is already the world's largest diamond producer by volume of stones, but aggressive pricing could make the business worth as much as $15bn, taking it past De Beers to become the world's biggest diamond miner by value.

As for De Beers - well, the winds of change are blowing there, too. Last year, diversified miner Anglo American (AAL) bought the Oppenheimer family's remaining 40 per cent stake for $5.1bn and now owns 85 per cent of the company. And in mid-2011, De Beers hired a new French chief executive with no experience in diamonds, mining or South Africa in order to bring in a "new pair of eyes" - at least that's what Nicky Oppenheimer, its former chairman, said at the time.

Granted, the company still churns out between 30 and 40 per cent of the world's rough diamond production annually, but its grip on the industry is persistently loosening. In 2000, it was about 50 per cent and in 1990 a staggering 80 per cent. Gem production also slipped by volume last year to 28 million carats from 31.3 million in 2011, although the diamond group says this was in line with its strategy of matching supply with market demand and falling prices.

 

Supply crunch

So what does all this change mean for the industry and for investors? Over the short term, not much. The operating assets of all four companies will continue regardless of their ownership structure. However, asset sales by the majors present an opportunity for middling players to buy assets and raise their production profiles, such as Dominion’s purchase of Ekati.

But in the long run, the structural changes at the top of the industry will doubtless take their toll on overall production. Small, emerging players typically don't have the financial or operating capabilities to build challenging new mines. Many of the majors' existing mines are ageing and won't be replaced either, raising the prospect of a serious supply crunch further down the line.

 

Different cuts of diamond equities

CompanyTickerLast priceMarket cap 1-year price change (%)
Retailers
SignetSIG4,475p£3.6bn58
Tiffany & CoNYSE: TIF$79£6.6bn42
SwatchSWX: UHRCHF555£19.3bn57
Compagnie Financiere RichemontSWX: CFRCHF84.15£31.9bn62
Luk FookSEHK: 590HKD18.94£938m24
Miners
Rio TintoRIO2,880p£53bn4
Anglo AmericanAAL1,540p£21.5bn-24
Dominion Diamond CorpTSX: DDCC$15.8£849m27
Petra DiamondsPDL115p£573m-12
Gem DiamondsGEMD133p£184m-37
Gemfields ResourcesGEM 24p£131m-22
Firestone DiamondsFDI2.95p£17m-49
DiamondcorpDCP4.1p£11m-16
Explorers
Stellar DiamondsSTEL1.5p£4.6m-50
Paragon DiamondsPRG5p£10.2m-76
Karelian DiamondKDR0.71p£0.6m-6
Namibian ResourcesNBR4p£2.6m14
Botswana DiamondsBOD2.5p£3.6m24
Sunrise ResourcesSRES0.56p£2.2m-14
£1=$1.53 £1=CHF1.46 £1=HKD11.92 £1=C$1.59

 

IC VIEW:

We believe demand for diamonds will ultimately outpace supply, driven by the rapidly growing middle-class in Asia and accompanying increase in disposable wealth, coupled with an economic recovery in the US, which singlehandedly accounts for well over 25 per cent of global diamond sales.

Investors, however, can't easily buy physical diamonds and there are no exchange traded funds (ETFs) because, unlike gold or oil, there is no standard international price for them. Each one is unique and values depend on cut, colour, clarity and carat, leading to thousands of different combinations and values.

Clearly, equities are the easiest route in. Gem retailers look expensive right now, but they are certainly the least risky option and any increase in demand will drive profits. Miners, meanwhile, may not be for the feint-hearted, yet they are the cheaper way in and a seemingly inevitable supply crunch will bring benefits longer term. Given funding and investor interest has all but dried up we’re giving junior mineral explorers a wide berth for now.