Diamonds: an alternative asset class?

2 12 2009

I have flagged earlier this autumn that diamond prices were going to rise significantly in the Zeniths and Abysses entry. Unlike other minerals, investment in diamonds is not a straightforward endeavour as the gems are not traded in an open market and that the two main producers, that possibilities for equity investment is limited as the main producers, DeBeers and Alrosa, are unlisted. There is however a push to develop diamond as an alternative asset class, which could lead perhaps to a diamond fund of some sorts.

On November 17th, the World Federation of Diamond Bourses, an organization founded in 1947 to provide bourses trading in rough and polished diamonds with a set of common trading practices, endorsed a suggested retail price list for different categories of diamonds. This suggests that a basic market infrastructure for diamonds being developed. Considering this, it is worth asking if diamonds could soon become a widely traded good. This would be just short of a revolution for the diamond industry.

Diamond retailing and marketing: current world order

Diamond sales have usually taken place through tightly knit networks of dealers and retailers. More than half of the world diamond production is retailed through the Diamond Trading Company which is the sale and marketing arm of DeBeers. Not only does it market DeBeers’ production but it is also mandated to retail a part of Alrosa’s production under an agreement that is not exactly pleasing European regulators and that is meant to be phased out completely this year. Anyhow, the Diamond Trading Company supplies to a limited number of sightholders (e.g. clients) which are selected carefully (the company lists only 111 sightholders worldwide).

Here is an excerpt of DeBeers “Sight and Sightholders” web page

As demand for rough diamonds outstrips supply, the DTC uses an objective set of criteria to judge which businesses it will supply, known as Supplier of Choice.

This selection process is designed to ensure that the companies the DTC sells to are the best businesses for the categories of diamonds they are applying to buy.
The DTC has recently published the list of Sightholders that have been awarded supply until March 2011.

What I find surprising in this excerpt is that the company mentions that the demand for diamonds exceeds supply. NOT! There is no natural shortage of diamonds. At present, the absence of transparency in diamond retailing has contributed a great deal to the mystique and the ever increasing price of diamonds. Marketing and the control of supply have made the gem a coveted luxury good despite its common occurrence in nature. The “A diamond is forever” line was carefully crafted to discourage the resale of diamonds and thus keep them off the market.

In sum diamonds are niche products and commodities at the same time. At present the focus is more on the gems being luxury items rather than commonly traded goods. However with the push in favour of diamond becoming an alternative investment class, so the current focus could be changing.

An alternative asset class?

Is the interest in diamond investment possibly threatening the current world order? It could but it seems that the main producer is not keen to see diamonds being traded as commodities or becoming the anchor of funky financial products.

DeBeers does not voice any concerns against investment in diamonds in principle, it is wary of investments conduits that treat the gems as commodities. Stephen Lussier, head of corporate affairs at De Beers stated that “our view on the concept is that it is more like art investing and less like commodity investing.” At present, there are a few funds investing in diamonds. These however focus on very rare and unique gems that are particular due to their size or colour. Like this one.

De Beers has also been known to discourage investment in diamonds because they perceive that bubbles prices followed by sharp falls are bad for consumer confidence in diamond as a long-term value. They also want to prevent speculation from impacting the jewellery sector.

I assume that DeBeers is probably a sufficient force in the diamond market to prevent the development of a “commodity-like asset” for diamonds. The company’s view expressed above is probably shared by companies that extract diamonds exclusively. However among the four big producers, Alrosa, DeBeers, BHP Billiton and Rio Tinto, two are big integrated mining companies which are prone to have difficulties in adapting to the niche characteristics of the diamond market and could perhaps see some benefit to selling their production through more open markets.

I assume that there are difficulties related to the development of diamonds as an asset class. The extreme differentiation of the gems (through carat, cut, clarity and colour) makes pricing an intricate exercise. Investment in diamonds can be unappealing due to their low liquidity and fungibility. Still, it is perhaps not impossible to see changes in the way diamonds are traded.

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Zeniths & Abysses

20 10 2009

The mining and metals community, since the beginning of the year, has had love for copper and gold only. Other metals unless they bottomed tragically were left outside news coverage as average performances are a bore to report on. It now seems that copper and gold may have reached their zenith as other metals and minerals are ready to take off

Gold: its 15 minutes could soon be over…

With gold reaching a new record price almost everyday, how dare I tell you that the fun may be over? With speculation being the sole driver of price increases, the enthusiasm of some will eventually deflate. Investor switching out of gold exchanged traded funds is indicating that to some degree. Since Q1 inflows in gold ETFs followed by Reuters has been steadily decreasing. In Q3 inflows amounted to just over 697,000 ounces in Q3, against 995,000 ounces in the second quarter. The weak physical demand is worrisome and leads to question the sustainability of current gold prices although they are expected to remain around the US $1000 level for the next few months as USD remains low.

Copper: feeling the pinch?

Are prices running ahead of demand? 5-month record high LME inventories can give an indication of that.  Chinese stockpiling, improving macro data and new investor cash have helped copper prices more than double this year but Chinese demand for the metal has been declining for three consecutive months as stockpiling slows. Freeport-McMoRan Copper & Gold Inc said on Monday (Oct 12th) that the copper market’s prospects for next year are as yet uncertain and a strong Chinese economy will be key to demand.

Silver: in no way second.

Like I mentioned about a month ago silver is doing well and will continue to do so. This year silver has taken much of its price direction from gold (and copper to some extent), With half of the demand for silver coming from industrial uses, the expected economic recovery will further propel prices for the metal.  Silver prices have already increased 87% this year while gold prices have increased 48%.

Diamonds.

Rough diamonds prices have been picking up in the past weeks (Rio Tinto raised its prices by 15%) and companies have restarted mines and processing capacity which is good news after  prices falling 65% this year.

 It is unclear if demand is rising in developed countries as producers are unsure whether the increase in sales is due to restocking ahead of Christmas or to genuine demand growth. That is what we will find out after Christmas. In the meantime, strong growth in demand can be seen in China and India.

All things considered, it could be secondary to determine whether demand is really picking up as the supply of diamonds is at so tight a price bubble may be expected according to RBC Capital Markets’ report titled “Diamonds – Where Will All the Rough Come From?”. The bubble-potential stems from the top diamond producers reducing their output significantly this year whilst new mines will be operational in 2011, at best. Leading to 2011, we expect African and Russian mines, which are older, to start producing less.

Nickel: your ultimate underdog

Word on the street is that nickel prices may have turned the corner. Nickel now has a new floor price and will be a top performer in an upcoming commodity supercycle underpinned by growth in Chinese demand. This is what was reported from the Australian Nickel Conference. Those conclusions sound like echoes from a previous commodity boom, just as if a consultant recycled content from a 2007 presentation.

Still, it can be interesting to have a look at nickel in light of its longer-term prospects due to its uses in new alternative energy forms such as nuclear, solar and wind that could help broader nickel uses beyond stainless steel which accounts for two-third of nickel demand. Despite stainless steel output rising 24.5% from Q1 to Q2, nickel prices have remained significantly low as LME inventories remained high as the LME is the market of last resort for nickel and does not deliver ferronickel, the material of choice for stainless steel. With idled capacity resuming operations, the next big move for nickel is expected to be on the downside.

Conclusion
Shortages or tight supply is expected to be an issue for commodities as idled capacity could take time to restart. Prospects are uncertain for many commodities as Chinese imports are expected to lower for the second part of this year although this does not make consensus. Of note, Goldman Sachs is cutting its exposure to commodities as other banks like JPMorgan Chase have increased their exposure steadil throughout the year. More on that here.





Rio Tinto and BHP Billiton Merging Operations- The Sequel

10 09 2009

Well it seems that I got scooped by The Australian. Now that the news is out, let’s add to it because I feel that the article that was published in the Australian newspaper forgets a few important things worth mentioning.

In short, it was reported on Tuesday that Rio Tinto and BHP Billiton were considering merging their diamond operations in Canada’s Northwest Territories as both the companies’ mines are adjacent. Should you be ready to unleash your enthusiasm at the prospect of Pilbara joint venture sequel, let me remind you that the benefits arising from this will be limited. The potential for synergies arises from the sharing of infrastructure, staff and the possibility of a marketing joint venture.

The Australian did not mention that Rio Tinto’s Diavik diamond mine in the Northwest Territories is an unincorporated joint venture with Harry Winston Diamond Corp. The latter has a 31% stake in Diavik following the sale of a 9% stake to Kinross Gold Corp in March 2009. Well Harry Winston Diamond Corp has a First Right of Refusal in the event of an acquisition of Diavik assets. I would assume that acquiring Harry Winston Diamond Corp would be a necessary first step to any deal involving BHP Billiton and Rio Tinto in the Northwest Territories.

From what I head heard in the past weeks, BHP Billiton was contemplating a $10 billion investment in Northwest Territories diamonds. Rio Tinto was rumoured to want to sell its diamond operations earlier this year as it sought to sell non-core assets to address its debt-problem. Could BHP Billiton just end up acquiring the Diavik mine as it’s probably a simpler route?