Rapaport Magazine

The "W" Effect

By Martin Rapaport
RAPAPORT... It is good to see diamond prices stabilizing and confidence returning to the diamond trade. The initial shock of the global economic crisis is wearing off. The trade is getting used to lower price levels and beginning to feel comfortable again. While the big-stone market remains highly problematic, 2-caraters and smaller sizes are selling relatively well. Rough sales are picking up and Indian cutters are returning to work. One can sense the beginnings of a return to the normal ebb and flow of the diamond trade.

Now I don’t want to rain on anyone’s parade or harm the fragile market mood. But we must ask: Is this recession over? Will everything now be OK? Will we return to business as usual?

The improved market sentiment is an obvious reflection of the recent boom in global equity prices. The S&P 500 peaked at 1,576 on Oct. 11, 2007, and then dropped 58 percent to 667 on March 6, 2009. On Friday, April 24, it reached 866, a 30 percent jump over the past seven weeks.

A key question is — what is the nature of the changes in the global economy? Let’s use the alphabet to help us analyze the situation. Most people relate to the simplistic V. Demand and prices go down and then they go right back up. Deep recessions bring steep recoveries. Things return to normal.

Many economists fear we may be heading to an L model. Markets go down and stay down for years. The recession ends but growth is too slow to enable a recovery. In the 1990s, Japan experienced the Lost Decade with 0.5 percent annual growth. Currently Japan is in a depression, with last-quarter gross domestic product (GDP) falling at an annual rate of -12 percent.

While some pessimists may point to an M model — given the fact that last quarter’s U.S. GDP fell to an annual rate of -6.3 percent — in my view, we are in a W or WW situation. We have experienced a bad decline and a sharp bounce and we will likely experience a few more of the same, but in the end, the diamond industry will come out stronger than ever. Here’s why.

President Obama is a young, aggressive, Keynesian Democrat who will throw however much money is necessary at the U.S. economy to pull it out of recession/depression. Figuratively speaking, if necessary, he will keep printing money until the world runs out of ink. The U.S. is not Japan and Obama isn’t just going to sit there in some “L” and take it. He will fight with all his might. Hence the upward spikes in the W.

But it’s not going to be easy. U.S. unemployment is at 8.5 percent and probably headed to 10 percent. Thirteen million Americans are out of work, with an additional 600,000 losing their jobs every month. Retiring baby boomers, the wealthiest segment and a significant 25 percent of the population, have lost 35 percent to 45 percent of their wealth as retirement savings plummeted along with the stock market and housing values.

Older people are scared and scarred. They are moving into saving survival mode and cannot be relied upon to fuel consumer spending. Most young and middle-aged Americans have also reached their credit limits. The era of excessive “spend-what-you-don’t-have” consumerism has ended. America can no longer fuel economic expansion through consumerism based on artificial wealth. That bubble has burst. Hence the downward spikes in the W as Obama struggles with the limits of Keynesian theory. Not all economic problems can be solved by throwing money at them.

Fortunately, diamonds are a global commodity and while GDP in India and China have declined, they are still expected to grow at 4 percent and 6.5 percent, respectively. These economies with a combined population of 2.5 billion are now learning how to generate local consumption and economic growth without America or Europe. Once their engines run independently, we will see unprecedented global economic growth — probably too much, too fast.

And this brings us to the upward-moving conclusion of the W. While it seems absurd to talk about hyperinflation in the current severe deflationary environment, the fact is that Obama is trading off current economic survival for future inflation. Given the amount of money being pumped out and anticipated commodity demand from India and China, double-digit dollar inflation appears inevitable. Diamond prices in dollars will go up, not just because of Asian and/or investment demand, but because the dollar will decline relative to other currencies. Of course, at some stage, the U.S. will sharply increase interest rates to shut down inflation. But that’s a different W.

The bottom line is that I am warning the diamond trade not to expect straight-line growth out of the current crisis. There is a great likelihood that some things may get worse before they get better and, in spite of the current good mood, diamond prices may be subject to further decline before recovering. Act carefully and make sure to conserve sufficient cash. Do not put it all on the line and try to make back losses quickly. This may be a false bottom.

While I understand the need to retain and support experienced cutters, the recent surges in rough prices are alarming, dangerous and unsustainable. Cutters are warned to consider the potential risk of future downward price pressure and not overpay for rough.

In conclusion, prices have stabilized and trade confidence has improved but this recession is not yet over. At this stage, money is scarcer than diamonds.

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

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May 25, 2009 8:47AM    By Lisa
Wonderful article!
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May 20, 2009 4:31AM    By Sandeep
interesting though rap, hope you're wrong
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