Stall and Spin

RAPAPORT... About 30 years ago, I learned how to pilot a single-engine aircraft, a Cessna 150 to be exact. One of the most important lessons was how to handle a stall and spin. A stall takes place when the plane heads up too sharply, loses lift from the wings, gets pulled down nose first by the heavy engine and then spins. Not a pleasant experience. You become disoriented as the earth comes rushing up to your face and you think you are going to die.

Your natural instinct is to pull back on the wheel and get your nose up. But if you do that, you will certainly crash. The trick to being a good pilot is to control your instincts and deny your vertigo. Push the nose down, go deeper into the dive, straighten out, get lift under your wings and slowly climb out of the dive. When you are out there alone at 8,000 feet practicing your spins, it gets simple. Fight the external forces and you die; go with the flow and you live.

While comparisons to the current situation in the diamond industry are obvious, the solutions are less so. What is clear is that the diamond trade can no longer afford disorientation and denial. The impulsive and instinctive industry reaction to protect inventory values at all costs is a sure way to bankruptcy. While there is nothing to stop suicidal firms from self-destructing, one would hope that reasoned minds and rational solutions will prevail. Recognition that survival requires the diamond industry to lower prices to meet demand is a good first step.

What is necessary for the industry is not necessarily the way forward for individual firms. Companies and individuals that have either no debt or enough cash to pay off debt can afford to wait out the difficult market by maintaining high asking prices. Some firms that can afford “not to sell” have been offering goods on memo, at prices some 30 to 35 percent higher than cash transaction prices. This huge spread between memo and cash prices is healthy, justified and necessary as it rewards those who are willing to hold inventory or pay cash for diamonds with significant profit margins. Jewelers should wake up to the fact that if they are not willing to pay cash, they are not entitled to cash prices.

The position of companies that are over-inventoried and underfinanced is less flexible. They have to sell. It is not a matter of price, profit or loss; it is a matter of survival. These firms are in desperate need of fair cash markets to sell into. The idea that there is no cash market for diamonds and/or that cash prices need to be hidden to protect the inventory value of sellers is, in my view, false, illegitimate and evil. How can we, as an industry, sell diamonds as a store of value and then refuse to buy them back in troubled times?

We must recognize that confidence in diamonds is a direct function of the diamond trade’s ability to turn diamonds into cash. Consumers who have been decimated by the financial crisis cannot be told there is no market for their diamonds. Firms that need to pay their suppliers or banks must have a fair way to sell their inventory. While cash market pricing transparency is a threat to firms that wish to protect inflated inventory valuations and/or charge high prices, it is a vital necessity for the establishment of efficient cash markets and the survival of the diamond industry.

The true test of the diamond industry is not how much money we can make during prosperous times, but rather how we handle ourselves in times of crisis. Do we have the integrity, honesty and pricing transparency necessary to support efficient cash markets? Do we provide liquidity to firms and individuals that desperately need cash? Do we stand behind our diamonds?

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Article from the Rapaport Magazine - February 2009. To subscribe click here.