Chaim Even-Zohar’s latest memo reveals the diamond industry in despair. At the moment Diamonds are not being sold to the market of consumer and what we see is inter-trading only. Banks do not see new money coming in, and while they hail the fact that debt went down by 20%, how much was due to real sales and how much was due to squeezing the empty pockets of the industry? The cancer has reached the producers, who act irresponsibly and pour billions of dollars into the market with the only short-term goal of survival. Alrosa lost half a billion dollars this year and De Beers struggles to finance its debt. All in all, somewhere along the line the industry forgot the consumer.

We all know the truth about diamonds for investment (short answer: they’re not), but the new trend that big players want to establish just shows their level of despair, trying to play on the world’s ignorance. This is not the first time that the trade, championed by De Beers, has done so. The world has believed that “all diamonds come from De Beers” and if you do not have a De Beers diamond, something is wrong with your diamond. I do not blame De Beers for not correcting this perception, but they were happy with this ignorance. What we see now, this attempt to attract investors, is something really dangerous. This raises some painful memories. During the heydays of the diamond boom before 1980, a Belgian worker decided to buy some diamonds for investment. When he came to us some ten years later with his parcel, we looked at it and literally had tears in our eyes. Here was a hard worker with a permanent layer of dirt under his nails and who had bought diamonds with full faith that his purchase was a good value that would appreciate. In actuality if he got 5% of his investment, he would have been lucky.

This was not an isolated case–I have a personal example: When my uncle left our company in 1975, he took, as part his compensation, a few parcels of polished goods that were estimated well below market price. When he tried to sell these goods twenty years later, he hardly recovered his investment even after repolishing and regrading many of the goods.

We also can’t forget the $1 trillion of goods at market price that are in the hands of consumers — these goods will be worth much less when consumers try to dispose of them. Jewellers pay about a third less on average for the same goods when going to their suppliers. When they buy from the consumer market, they pay a lot less for several reasons: they have to pay cash, the goods won’t always sell easily, and sourcing from the consumer market is not always steady.

On top of this, the jewellers’ market is very narrow and quite often they will try to move it up the supply chain to their supplier or supplier’s supplier, reducing the value they can offer even further. If the market tries to market diamonds for investment, they are literally cheating the market. Most of the goods that will be sold will fetch only a fraction of the investment when they are resold, even without any more mining. And even extraordinary large and special diamonds, which might have been a good investment in the past, won’t be a good investment if many of them are sold later on at lost or close to par.

The diamond industry may be beginning to recover, according to De Beers executives who spoke at the Diamond Town Hall Meeting at the Antwerp World Diamond Centre earlier this month.

Gareth Penny, De Beers managing director, said “diamond inventories have fallen to levels which have justified increasing the mining production of the De Beers mines after it had been reduced by some 90 percent in the first quarter of the year.” He also said “The demand for De Beers rough diamonds is picking up,” and that “De Beers production is increasing to keep pace with demand. Retail sales have also shown an improvement.”

He noted that in the period from 1970 to 2009 there were four major recessions in the US, and in the five year period following each, rough prices rose sharply. Penny expects the same to happen this time. I do hope he’s right, and that demand truly is rising. It would be all too easy for him to just tell the crowd at the town hall (including sightholders) things they want to hear.

Photo by Hamza Hydri

Here’s an interesting article on the state of the diamond market in Russia–they’re stockpiling diamonds while they wait for demand to return to protect the market in the long run. They’re also beginning to take charge in advertising diamonds generically the way De Beers used to. At the end of the article, the author sums up the major problem in the diamond industry, but also points to the solution:

“We have to tell people that diamonds are valuable,” [Aleksandr A. Malinin, an adviser to the president of Alrosa] said. “We are trying to maintain the price, just as De Beers did, as all diamond producing countries do. But what we are doing is selling an illusion,” meaning a product with no utility and a price that depends on the continued sense of scarcity where there is none.

At the Alrosa unit that receives diamonds, called the United Selling Organization, where about 90 percent of the output of the Siberian mines arrives for processing, Elena V. Kapustkina pours about 45,000 carats of diamonds though a stainless steel sieve every day to sort them by size.

“It’s just a job,” she said.

When asked whether diamonds had lost their romance for her, Ms. Kapustkina paused, looked down at the pile of gems on her table and blushed.

In fact, she said, her husband, a truck driver, gave her a half-carat ring 22 years ago. “Of course I love it,” she said. “It’s from my husband.”

I hope Malinin’s cynical comments won’t undermine the industry. The industry should really be focusing on people like Elena Kapustkina, who feel an emotional connection to their diamond. Understanding how people interpret luxury and how luxury can give people positive reinforcement will give marketers a distinct advantage–it’s the direction in which luxury marketing is going.

De Beers new emphasis on “enduring value” is achieving widespread coverage.  Many in the trade, like JCK magazine, really WANT to believe the message!

Reading through the hopeful message of De Beers, it is easy to find many rational arguments that diamond prices are sound, but the truth is, the arguments are flawed.

The first of the arguments is that diamonds are of “enduring value”. I simply do not know what enduring value means here, given that we all know that diamonds are not a viable form of investment and never have been.

The second argument is that it is better to buy now because the supply of diamonds is limited – as existing mines are depleting or even depleted and no big mines are on the horizon.  The industry has been spinning this yarn for years when it wasn’t true.  So how can we expect consumers to believe us now?

It will be particularly interesting to see how this particular argument helps in convincing a retail customer who stands in front of display-case after display-case overflowing with diamond jewellery; not to mention the immensity of the diamond jewellery overhang, lying dormant in domestic jewellery boxes.

The final argument DTC makes is that among really affluent buyers, price is not an issue. I do not know who these affluent people are and what their weight might be among diamond buyers. Data shows that since the mid 1980’s the “sweet point” of diamond purchases simply did not change. In the US, with its social multi-layered demography, most of the diamonds sold are in the range between $2000-4000 while in Japan this “sweet point” still hovers around $2000.  For diamonds, sold as commodities, price does matter!

Of course this could all change if we reverse the tide of the 1980s and return to first principles.  Diamonds are luxury, pure and simple. They must be sold as such.

The one thing we know about luxury is that it is ultimately irrational (the subject of my PhD – thankfully now completed!).  Luxury is a fine example of the fact that that the value for money is NOT what we seek. When we ask people for a definition of luxury we usually get two answers.

First, we hear that luxury is expensiveness and second, we hear that luxury is unnecessary (or superfluous). In this sense, diamonds are, in principle, the pinnacle of luxury – as they are, quite literally of no use whatsoever.  When it comes to valuation, saying that luxury is unnecessary opens the door to premium and unbounded, personalised pricing – the antithesis of commodities.

Instead of recognising and embracing the irrational consumer, since the 1980s,  De Beers has adopted a rational line, looking to “educate the customer”.

This is still the producers’ strategy – at the expense of the industry , which simply has to follow the leader’s line.

However, as these ‘rational’ arguments will never convince any serious customer, we have seen and will continue to see a lower proportion of people interested in diamonds.  Other luxury offers, by contrast remains resolutely irrational – and many categories are indeed relatively resilient to economic considerations. Purchasing of luxury is ultimately an irrational activity.

Of course it is just possible that during the coming six weeks American customers will storm the jewellery stores and clear up everything still in their vaults delivering a knock-out blow to the recession.

My feeling, though, is that we are looking less at a boxing match and more at a game of Russian roulette that may well send the final blow to the de-facto bankrupt industry.  Doubling up the Christmas ad spend and pleading with consumers to value ‘their commodities’ at heavily inflated prices is a very big gamble indeed.

I propose the following short prescription for the diamond industry’s long-term recovery:

First and foremost:

A true leader must emerge from deep within the industry at the level of primary production.

(2) This leader must have the ability, confidence and commitment to squeeze supply when necessary.

(3) This leader must recognize and solve the question of “enduring value” at the retail jeweler level.

(4) Retail jewelers must be trained and retrained on true luxury and understand it inside and out. This goes far beyond anything attempted by the industry to date. It is the cornerstone to the health of the industry medium and long term. Isaac speaks to this when he mentions irrational purchases.

DeBeers had the formula right prior to the 1980’s, but steered off course…they need a map and they need to learn to read the signs

(5) The practice of ‘Memo’ing goods, except in the instance of a 10 days special request for an established client must be relegated to the past.

(6) Jewelers must gravitate to partner suppliers who can work effectively with them to eliminate bottlenecks in supply.

No diamond should sit in a jewelers inventory for extended periods of time.

(7) Primary polishers must invest their profits (which means they must first have some profits) into their business to improve infrastructure (equipment) and train a new generation of diamond polishers. If a business is profitable then good business practice will lead those who survive to take these steps independently. Those who refuse to move forward with innovation will eventually close their doors.

(8) Consumers should be allowed to rediscover the hidden value of diamonds – The essence of self expression. Being able to express in action what one can not express in words.

Forget the 4C’s. Forget about diamonds as an investment. Diamonds are a symbol of the irrational – LOVE.

(9) Bank debt must be reduced significantly. There will always be a necessity to work with others money, but it is out of control.

In my view the industry debt is most likely 5-7 times more than is healthy.

(10) Banks must be enabled regain confidence in the price of rough and the downstream distribution (this is once again a a function of strong leadership and even political guarantees by governments whose revenue depends on the diamond industry’s health).

I read the comments of DTC and confess my utter amazement…

Take a look at the Enduring Value Media Release.  Among many other things they argue that the medium and long term fundamentals of the diamond industry are strong (!?)

That’s rings about as true as John McCain stating that the fundamentals of the US economy are sound just days before the biggest meltdown of the US financial sector since the founding fathers walked the land.

I also take real issue with whatever data collection indicates that diamond jewelry is the #1 gift for holidays 2008 “by a wide margin”.  I can report to you, direct from Main Street USA, that the bigger decision is whether gifts will be exchanged at all.  It is all well and good that consumers desire “fewer, better things”, but the real pocketbook world is a bit more complex than that.

On the other hand, I do acknowledge that spending a gazillion dollars to market to consumers the idea that diamonds are a great long term store of wealth probably feels like only viable option available right now.  What other choice do they really have? Just run the ads and hope for the best.

There is a real risk that the old ‘kill the messenger theory’ will come into play here.  Being the bearer of bad tidings is never easy.

However, I think Isaac has a point.

Our industry is in a real mess. No doubt about it.

We have been looking for some time now for a new style of leader to step forward and help navigate the industry through this mess.  I’m sure DTC feels it’s acting in the best interests of the industry to protect the PRICE of diamonds, but I would urge a fundamental rethink to safeguard the VALUE of diamonds

The move of Martin Rapaport was a shot across our bows.  And it was definitely was heard around the world, but remember that it was just a warning shot.  It has had absolutely no impact at the consumer level and I have serious doubts that it has had any real impact at the jeweler level.  However, the killer shot is being loaded into the cannon – and it may be unleashed unless someone steps into the leadership role, changes the industry heading, and puts the ship on a path to safer waters.

Here is my idea – If DTC wants to really boost demand they should invest directly into the local retail jeweler.

It is the DTC, not consumers, who have lost confidence in the ‘enduring value’ of diamonds.  They are the ones who do not own any diamonds of their own.  They only borrow diamonds, sell them to consumers, and eventually pay off these diamonds when the risk has reduced to zero.

Protecting this ‘enduring value’ is the marketing question that should been receiving the undivided attention of DeBeers. Given where we are the answer of how to fix this problem is best left to the highly paid consultants. But from the street level, it seems like a matter of incentives (or disincentives) for consumers to purchase.

In an attempt to push product down the pipeline for the past 20 years, the industry has eroded and destroyed this enduring value in the eyes of the retail jeweler.  ’Enduring Value’ looks like a return to basics. And about time too.  But is it leadership?  Not in my view.

Yours, Randy Pearson,
Registered Supplier, AGS

Economic difficulties are hitting the diamond market. Will there be a holiday slowdown? Let’s look at some recent industry news:

DeBeers production of rough diamonds is slowing slightly, down 4.3% in the 3rd quarter of 2008 compared to the 3rd quarter of 2008. However, the prices they’ve been able to achieve for their rough diamonds at auction recently have held up (unlike BHP Billiton, whose prices have dropped 35-40%).

An industry trade group (India’s Gem & Jewellery Export Promotion Council [GJEPC]), a large producer (Alrosa) and a whole country (Botswana) have all said that the economic crisis is affecting them. GJEPC asked producers to offer fewer rough diamonds over the next few weeks so that the market could stabolize; similarly Alrosa said it would cut its supplies. Botswana has also said that the economic crisis has affected its diamond exports; the country is solvent for now but could be hurt if the recession lasts for a long time.

What does this mean for the holiday season? RBC Capital Markets is predicting disappointing diamond jewelry sales in the US for the holidays. The International Council of Shopping Centers predicts that chain store holiday sales will grow, but the focus will be on basic goods.

All this news suggests to me that a holiday slowdown is on the horizon, though DeBeers being able to hold its prices suggests that those companies with the right offerings will be able to weather the storm.

Having previously dominated diamond supply and exercised near total control over diamond distribution, the diamond industry market leader De Beers now accounts for just 40% of global diamond production and 45% of distribution. In the face of competitive and regulatory pressures, De Beers has recently sought to adapt its role from being the custodian of the industry to acting merely as a major player. However, its retreat from a position of industry dominance is creating tensions within De Beers and among industry participants.

This paper seeks to explain De Beers’ behaviour and the reaction of the industry in terms of paradox management and identifies the requirement for a new form of leadership to replace the previous monopoly situation and guide the diamond industry into a better future.

Mostovicz, I., Kakabadse, N. and Kakabadse, A. (2007), ‘The diamond industry as a virtual organisation: Past success and challenging future’ Strategic Changes, December 16(8), 371-384. http://doi.wiley.com/10.1002/jsc.809

Photo by mafic

Moti Ganz, the chairman of the Israel Diamond Institute, gave an interesting speech last week at the Third International Rough Diamond Conference in Tel Aviv. Speaking on the topic of producer strategies, Ganz argued that there is too much polished diamond on the market because manufacturers are polishing when they don’t have customers lined up to buy the stones.

Ganz asked rough producers to refrain from the use of tenders and auctions as a way to unload rough, saying they hurt manufacturers and the producers themselves in the long run. He also called for rough producers to help promote diamonds as a luxury product in the manner of De Beers, who spend 3% of sales turnover on advertising. His reasoning:

In the long-run this investment will be repaid, as the awareness of diamonds increases in the consumer market. The diamond is not a simple luxury product. It is not a bag – you buy it one week, and next year when it goes out of fashion, you buy another one. Women give bags that are out of fashion to their housekeepers. I have never heard of a woman who gave her diamond jewelry to a housekeeper. They pass on diamond jewelry to their daughters and granddaughters or set them in new jewelry. The diamond never wears out in their eyes. Therefore, the investment in marketing must be more sophisticated than that of other luxury items.

I agree–diamonds get passed on and the love they represent only grows with time. But should the responsibility to promote diamonds fall higher on the supply chain? I think Ganz might be on to something, if a new marketing effort from rough producers is done in a coordinated way.

Read Ganz’s speech here, and an A-DX.net piece about it here.

Two critical diamond industry events have thus far passed under the radar of mainstream media. They deserve an airing here as they signal a shift to open-access, transparent, and globalised diamond trading – a far cry from the industry’s heritage in tight handshake-based relationships.

First: The creation of a $400m Diamond Circle Capital Fund, an investment fund which will invest in $1m+ high end diamond. The fund is the brainchild of commodity asset management specialist Diapason.

Second: The development of a diamond futures market by industry ‘wild child’ Martin Rappaport, based on ‘bread and butter’ brilliant diamonds – high quality rounds between 1.01 and 1.19 carats. The classic engagement ring ingredient.

Both measures aim to address fundamental weaknesses in the existing diamond trade: while consumer demand is solid (if not exactly strong) and extraction capacity is solid (if not exactly strong), the centre of the diamond pipeline is in deep trouble. The distribution arteries of the industry are clogged. Rough dealers, manufacturers and polished wholesalers are finding it hard to breathe. Both stock and debt levels are at record highs.

It’s the first move – the investment fund – that I want to address first.
According to industry commentator Chaim Evan-Zohar, these measures should attract much-needed external capital into the industry, and will enable manufacturers to shift goods which would otherwise get stuck in the distribution, or shifted on at a bargain rate; they need deep pockets to hold onto.

There are dozens of good diamond manufacturers who will not even try to compete for the truly large rough stones, because they cannot be sure that they have the right connections. The Diamond Circle Capital fund significantly widens opportunities for the trade to sell large polished stones.

As De Beers’s historic monopoly passes into history, a period of uncertainty emerged in which the industry needs new pathways to get goods to consumers.

After a long period in the dodrums, Chinese and Indian demand is on the rise for smaller goods, and oligarchs increasingly need something shiny to please their soon-to-be-ex-wives. The is now some hope that the industry may finally be emerging from its doldrums. This hope, and desparation at the status quo is encouraging a new wave of innovation.

Both these new measures rely upon the fact that diamonds can be traded as commodities. By picking narrowly defined segments – one highly volatile and one highly stable, the measures will introduce powerful, albeit potentially conflicting price signals into an opaque marketplace.

But the question is, who will this benefit. Does it really help manufacturers? Does it really help consumers? Critically, will it help investors?

For manufacturers there may well be be a one-time injection of funds as they sell difficult to shift of stock to the Diamond Circle fund, but thereafter, it’s unlikely the fund will have the sales capability to shift much stock. If it does, the potential for misleading transactions is immense. On the one hand it promises to set a benchmark by disclosing genuine sales figures rather than tax-cogniscent guesstimates. On the other hand, the integrity of these transactions will be very difficult to assure. What liquidity is there really in a rolling stock of 100 or 200 diamonds?

The proposed participants are actually rich rough dealers with little sales experience.
As one of the world’s leading retailers of large stone said to me:

Selling large diamonds is an art form, making the buyer feel like a queen. Manufacturers should stay well away.

Building on his observation, it’s not the business of a fund, or even, really, of an auction house to sell these diamonds. It’s quite possible that the fund may actually act to suppress value rather than enhance it.

Secondly, the fund is likely to have a disproportionate number of difficult to sell or ugly diamonds – if a dealer has a really quality large diamond he is likely to be able to find a more value-adding route for it.

The third point is that not all diamonds have value. Period. Some are just not saleable, at any price. Although the aggregation created by the fund is likely to smoothe out the risks of holding these diamonds, on average it will probably overvalue the diamonds it contains.

To conclude, and to challenge Chaim’s view, the simple truth is diamonds are NOT commodities. Treating them as such will not inflate value, it will only erode it…

The sooner the industry finds a way to step back from this abyss, the sooner it may regain a luxury premium.

I will comment on Martin Rappaport’s futures market in due course…wait for part II…