RAPAPORT... Fears of a global recession are driving down stock market and commodity prices. Are lower diamond prices a threat to the diamond industry? How can diamonds compete in the new deflationary environment?
By now, it should be clear that diamond demand, sales and prices are subject to the global economic environment. Whether you consider your diamonds a commodity, luxury product or part of a well-advertised, multimillion-dollar exclusive jewelry brand, the facts are the same. Stock and commodity markets around the world have crashed. Wealthy consumers have lost about $10 trillion dollars over the past two months. U.S. Baby Boomers, having seen their retirement savings halved, are not thinking about spending money on jewelry. Not only has the luxury wallet shrunk to the extent you need a loupe to find it, but the desire to spend on luxury and/or show off your wealth has become socially unacceptable and uncool.
Some diamantaires are in deep denial. Blinded by their huge inventory positions and narrow-minded, self-interest perspective, they cling to the false idea that diamonds are a magical, mystical product that defies economic gravity. They fail to recognize that De Beers no longer controls diamond prices and that buyers are not stupid. Buyers will not pay the same high price for diamonds irrespective of difficult and competitive global economic environments.
If diamond prices go up, it is natural, correct and necessary that they also go down. Attempts to freeze markets do not stop the inevitability of lower diamond prices when conditions so warrant. Refusing to sell diamonds as prices decline might be an option for wealthy diamantaires who wish to speculate on future price increases, but it can be a recipe for bankruptcy if firms do not have sufficient financial resources to ride out a downturn. The diamond trade must understand that it does not control diamond prices that are a product of fundamental, external, economic forces. Holding inventory is speculation.
Are lower diamond prices a threat to the diamond industry? The vast majority of the diamond trade makes its living on the profit margin, i.e., the difference between buying and selling prices. If prices go down and buyers pay a lower price, profit margins are maintained. The quantity of product sold increases as it becomes easier to sell diamond jewelry that is less expensive and more competitive with other luxury products — is this a bad thing? The only long-term beneficiaries of too-high prices are the diamond mining companies. They make the money while the rest of the trade carries the heavy burden of high prices. High diamond prices mean higher inventory carrying costs, higher credit finance costs, higher shipping and insurance costs and much greater risk. Higher diamond prices mean higher costs and lower profit margins.
Is the diamond industry in the business of holding diamonds or selling them? How much transactional profit are we sacrificing on the altar of artificially high inventory prices? Are we investing too much in marketing because diamond prices are too high for them to be sold in cash markets? While it is reasonable for firms to try and maintain their inventory values, the idea that diamond prices must be kept high at all costs is bad. Short-term inventory profits do not compensate for long-term lower profit margins.
Lower diamond prices are dangerous to the extent that they force the trade and banks to recognize the true liquidity value of their inventory. The banking sector, under extreme financial pressure, has become much more conservative. Liquidity and risk management have become major issues and may cause problems if not handled correctly. There is concern that lower inventory valuations might cause some banks to reduce loans, thereby forcing sales into an illiquid market, which would further reduce prices and lead to another loan reduction. Banks must be careful not to introduce a cycle of negative price pressure. While debt management and loan reduction are legitimate goals, they must be managed carefully in a world with less liquidity.
Over the past few months, we have talked about our expectations for inflation and the potential market for investment diamonds. The collapse of gold, platinum, oil and other commodity prices has created a new deflationary reality that must be worked through before our expectations of inflation can take place. Hundreds of millions of Chinese and Indian consumers will not disappear, but their rate of consumption has declined in the current economic environment. The stronger U.S. dollar has also played a role in decreasing inflationary pressure in dollar terms. In the current environment, it is unrealistic to expect investment demand to maintain price levels by replacing consumer demand for diamonds.
The financial crisis is creating a difficult environment for the global diamond industry. The challenge before us is to adopt proactive and flexible market attitudes. We must face reality honestly and openly. We must recognize, appreciate and have confidence in the powerful long-term appeal of our products and services. Instead of fighting the global economy and trying to artificially control diamond prices, we must learn to go with the flow and move with the markets. Volatile diamond prices are healthy because they force us to face the reality and true value of our diamonds in a complex and volatile world. While lower diamond prices present great challenges and opportunities, they cannot, and will not, destroy the diamond industry.
Article from the Rapaport Magazine - November 2008. To subscribe click here.