Trade Resources Industry Trends The Diamond Market Is Slowly Becoming More Disciplined

The Diamond Market Is Slowly Becoming More Disciplined

The diamond market is slowly becoming more disciplined. It needs to. With high rough prices, declining polished, less available credit and lower retail inventory levels, it has become increasingly difficult for diamantaires to turn a profit. Therefore, they need to carefully navigate the significant changes taking place to improve their position in the market.

Three changes are shaping 2015 into a watershed year for the diamond market as they will have a lasting impact on how the trade operates. The banks are reducing their available credit to the industry, businesses are being forced to adopt more corporate structures and the trade is realigning to lower, more efficient inventory levels.

While these are ultimately positive developments for the industry, it will likely take time for businesses to acclimate. There will inevitably be some consolidation in the interim.

The most significant change is in the lending environment. In truth, the banks made their big moves in 2013-14. ABN Amro announced its decision to reduce its financing of rough purchases from 100 percent to 70 percent, which took effect on January 1, 2014. And, KBC Group last year decided to close its Antwerp Diamond Bank (ADB) subsidiary, effectively phasing out $1.4 billion of industry financing.

Simply put, the banks – or their regulators – view the diamond industry as “increased risk,” as Erik Jens, CEO of ABN Amro’s Diamond and Jewellery Clients, stressed in a recent interview with Rapaport News, and such a classification makes the loan more expensive for both the lender and the recipient. Much of that risk relates to reputational issues and the way the trade conducts its business.

It’s not a good thing that banks are leaving the diamond industry. But it is good that they’re being more frugal. For too long, the easy supply of money fueled irrational rough diamond buying, which enabled rough price hikes. In the past six months or so, as diamantaires have had to foot more of the rough bill themselves, they have refused to take non-profitable rough forcing a price correction in the process.

Whether they’ve done so because they ran out of money or have adopted a more disciplined approach is anyone’s guess. Probably a bit of both, although one hopes that it is the latter. Either way, the responsible banks want their clients to focus on profitability rather than turnover and diamantaires seem to have gotten the message so far in 2015.

The question is if all the banks are responsible. There are certainly still concerns about the environment in India where some 60 banks are lending to the trade. It seems that the larger Indian banks are tightening their lending requirements as the regulators there have expressed concerns about the high number of non-performing assets in the industry. However, diamond businesses still have easier access to credit in India than in other centers.

There is also a question of new banks entering the trade, such as in the United Arab Emirates (UAE), which still need to prove their restraint as they increase their exposure to the diamond industry.

Encouragingly, the National Bank of Fujairah (NBF), Emirates NBD and Mashreq Bank, which each recently announced their entries into the diamond trade, signaled at last week’s Dubai Diamond Conference that they would allocate credit on a case-by-case basis and did not intend to fight established banks in the industry for market share.

Responsible banks are lending on a case-by-case basis with the promise that good money is available for good companies. A good company is one that is profitable and transparent.

Indeed, the second major change the trade is dealing with in 2015 is the move toward a more corporate structure. The banks require it of their diamond clients, and so do the major mining companies who want to deal with financially robust and transparent rough buyers.

Both De Beers and ALROSA insisted that their long-term clients should be working toward compliance with International Financial Reporting Standards (IFRS) in order to receive rough supply in 2015 and beyond. The mining companies have reasoned that the more the trade can demonstrate its transparency and adherence to financial regulations, the greater chance it has of attracting additional credit for rough purchases.

Therefore, the days of Mazal U’Bracha – doing business with a handshake, are effectively over. The industry is (rightly) being forced to abandon its archaic, trust-based business model in favor of proper reporting (and invoicing), with full financial disclosure and transparency.

While the banks and the mining companies have their own motives for insisting on these measures, the industry should take the opportunity to adjust its position in the market to match. The diamond trade, consisting of manufacturers and dealers, has historically carried the debt burden of the industry, and more recently carried the weight of its inventory. A better-structured business model might help ease that load.

In the past year or two, jewelry retailers, particularly the U.S. smaller independents, have streamlined their operations to hold lower levels of inventory. In addition, China’s expansion slowed. Consequently, more diamond buying is being done on a needs basis as orders come in, rather than to build up inventory.

That left excess inventory in the middle of the distribution chain in 2014 as diamond cutters maintained manufacturing levels and increased their rough buying for most of the year. However, as polished demand remained weak and liquidity shrunk, the trade reduced its rough buying and polished production in the past six months in an effort to stabilize the market by lowering supply.

It seems to be working as the market is slowly showing signs of improvement, even if cutters are still losing money on overpriced rough. However, the trade needs to maintain a more streamlined approach in order to garner sustainable long-term profits. In particular, it should avoid being wooed by those banks still offering easy credit for rough purchases. Secondly, manufacturers must avoid buying non-profitable rough as a matter of principle for the long term.

In doing so, the changes currently taking effect will surely benefit the diamond industry.

As a more profitable, well-structured industry, the trade will be less inclined to engage in reputation-harming business practices and will improve its risk profile in the minds of the banks and the regulators. More importantly, it will result in a healthier and more sustainable industry for the trade itself – even if there will be some growing pains and market consolidation in the process.

It may take some time to acclimate. And it will take a fair degree of discipline to bring about long-term benefits to these 2015 developments. But they are absolutely necessary if diamantaires wish to earn a profitable position in this challenging market place.

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