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Slow Down

Jan 5, 2001 10:42 AM   By Martin Rapaport
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Growth is great, especially when it keeps happening. After a while people take growth for granted, they expect every year to be better than the one before it. In general this is good, because positive expectations play an important role promoting trade confidence and optimism which are primary factors influencing the level of inventory accumulation. If people have more inventory they make more sales and encourage expansion of the industry.

For quite a few years the U.S. diamond industry has been on a fast paced double-digit growth track. Year to year polished imports increased by 19 percent in 1997, 13 percent in 1998 and 11 percent in 1999. While total polished imports for 2000 are not yet in, we can say that they have been incredible. Through September 2000 the U.S. imported $8.5 billion worth of polished, 36.5 percent over the same period in1999 and very close to the total of $8.787 billion for all of 1999. The U.S. diamond industry has imported more diamond than ever before in its history.

Overall, U.S. holiday sales and profits were disappointing and did not reach the growth levels many jewelers had hoped for. Flash reports are still coming in, but it looks like overall consumer retail diamond jewelry sales may have been a few percent below last year instead of the 5 to 6 percent increase that many expected. The bottom line is that diamond and diamond jewelry inventory levels are much too high.

The decline in overall U.S. retail sales growth is raising serious concern that the U.S. economy might be heading towards a recession. There is a lot of uncertainty about what the future will bring and sales expectations for the first half of 2001 have declined sharply. Retailers and their suppliers are very concerned about the future and there is a growing consensus that excess inventory in the diamond pipeline will have to be cleared out through the distribution system before new product is ordered. To some degree there will be continued and even strong demand for select sizes and qualities of diamond that are in short supply. However, the financial position of retailers that are over-inventoried and suppliers that are taking returns from major retailers will encourage a conservative approach to new diamond purchases in the first quarter. Simply put, money is tight and may get tighter. Furthermore, diamond sales from the cutting centers to U.S. retailers will probably slow down significantly for the next few months.

It is important to note, that just because sales did not meet overly optimistic expectations this holiday season does not mean they will not exceed overly pessimistic expectations for 2001. The U.S. is a very large, wealthy country and historically changes in consumer spending are moderate. While it is reasonable and rational for firms to be cautious and conservative in the months ahead they should recognize that America is not the Far East. Consumer spending will continue and diamond inventory levels will decline, opening up the way for increased diamond imports.

The problem for the cutting centers is the rather large U.S. inventory bubble. Sellers are going to have to be patient and wait for much of this inventory to be sold through. The old model of simply extending more credit to move more product will not work in the months ahead. It is time for the cutting centers to realize that the U.S. is not a dumping ground that can absorb infinite quantities of hard-to-sell diamond qualities. The U.S. is an important and vital consumer market that needs to be carefully developed and expanded. Given current inventory levels, the old saying, "if you don’t have it — you can’t sell it," is being replaced with "if you have it — can you sell it?"

The challenge for the diamond industry is to learn how to slow down. How to moderate cutting activity while maintaining reasonable levels of production capacity. We must learn to better manage our sales/inventory ratio’s. Firms that think they do not have to slow down and can simply keep on producing at the same levels should recognize that competitive forces are likely to have a very strong negative effect on prices for diamonds that are in oversupply. By all means, produce what you can sell and concentrate on sizes and qualities that are in strong demand. But recognize that this is not a good time for firms in the cutting centers to be speculating on large inventory positions of harder to sell diamonds.

The Wealth Effect

There are many explanations about why this holiday season did not meet expectations. Last year’s sales levels were unusually high due to the millennium and booming stock market. Expectations of growth over last year’s record levels may have been unrealistic. Furthermore, In spite of the extra shopping days, very poor weather conditions kept many shoppers at home and uncertainty about the U.S. presidential election hurt consumer confidence.

Perhaps the most important factor was that the stock market bubble burst. Consumers lost billions as high-flying internet stocks crashed during the holiday season. It’s hard to be thinking about a diamond purchase when your net worth is dropping by thousands of dollars almost daily. Adding insult to injury, thousands of overpaid internet groupies lost their jobs and speculative salaries. People who thought they were rich found out that virtual money is not the real thing.

The wealth effect plays an important role in stimulating diamond demand. Millions of consumers, particularly relatively wealthy consumers who are inclined to buy luxury products, made serious money in the stock market. This wealth, even though and perhaps because it was not cashed out of the stock market, gave many consumers the desire to buy something tangible to reflect their new prosperity. Naturally, the new paper wealth drove significantly increased demand for luxury products like expensive cars and lots and lots of diamonds. As NASDQ and its resultant wealth effect collapsed, the diamond demand created by this virtual wealth also collapsed. Undoubtedly, had NASDQ gone the other way, increasing by 40 percent instead of decreasing by 40 percent from September through December, consumer jewelry sales figures would have been way up far surpassing what would have been called conservative trade estimates.

Now if the wealth effect has a very significant impact on diamond demand and if perceptions of wealth are based on unsold shares in highly volatile stock markets then we should recognize that diamond demand might be extremely volatile in the months ahead. Consider what happened January 3: the U.S. Federal Reserve Bank in an unscheduled and surprise move, slashed interest rates to forestall a recession. In just one day the NASDQ surged 14 percent. Consumers whose "extra money" (i.e. money available for the purchase of luxury products like diamonds) has been sitting in the stock market suddenly found themselves with 14 percent "extra money." But who knows, the stock market is expected to "correct" today and the 14 percent gain might just disappear in a few hours.

While consumers are unlikely to respond to one-day changes, they are likely to respond to changes in their wealth over a reasonably short period of time. If the Fed somehow "fixes" the markets then perhaps our "slow down" forecast is completely inaccurate. The fact is that as long as large amounts of disposable consumer wealth are tied up in the hyper-volatile stock markets no one canreally forecast diamond demand in the months ahead.

The Big Picture

In spite of the volatile stock markets and resultant wealth effects, it is reasonable to assume that the U.S. economy is going though a natural development cycle. We have seen several years of very strong growth and at some stage the economy is due for a slowdown. Not necessarily a strong volatile negative correction but certainly a moderate decline in growth rates and/or demand. Sure, many things will happen, but over the medium term the overall momentum of the economy will adjust to normal cyclical behavior patterns.

Perhaps the best news about the U.S. economy is that we are already at very high consumer consumption levels, so even if there is a moderate decline we are still going to do pretty well. Some firms seem to be complaining that sales are "only" at or close to last year’s levels, but last year was really great. Even if we stop growing, or decline a bit, we will still be in pretty good shape. The U.S. will remain the largest wealthy country in the world. Lifecycle events such as engagements, weddings, anniversaries will continue and people will still buy a tremendous amount of diamonds.

The diamond industry is simply going to have to get used to more normal business patterns. There will probably be some unpleasant short-term shocks. Some firms like Montgomery Ward may go bankrupt. Returns from the major jewelry chains may be much greater than expected. Cutting centers will have to hold off sales until jewelers liquidate large unwanted inventory positions. However, over the medium term, consumer demand will hold up and the U.S. market will continue to absorb record quantities of diamonds. In the opinion of this writer, the party is not over, but it is getting more mellow for a while.

The challenge for the diamond industry will be to take it easy. Not panic. Not dump goods. Not buy and manufacture rough that results in polished that can’t be sold. The trick is simply to adjust our expectations and production to the new realities of the marketplace. This is a good time for the industry to retrench and rethink how it finances and markets its diamonds. As always this is a good time to come up with new and innovative marketing programs and diamond products. It is not a good time to just keep on mindlessly manufacturing unlimited quantities of any and all types of polished diamonds.

We have not discussed a number of important ramifications that will result from a slowdown in the diamond markets. Chief among them is the role of De Beers as the "leader" rather than "custodian" of the market and how the sales levels of the DTC and their competitors may impact diamond prices in the months ahead. Issues relating to price competition, inventory management and banking finance in the cutting centers are also of great interest. We plan to analyze these issues in an upcoming article.

In conclusion, the Yiddish saying "Kan boim vaxt nisht biz der himmel" ( No tree grows to the heaven) comes to mind. We must recognize the cyclical level of growth and development and take these cycles into consideration as we plan our business activities. Even if you do not agree with our views and think us overly pessimistic, sooner or later all of us need to think about how we can optimally and rationally moderate our business activities when market conditions suffer the inevitable downturn. Significantly, the saying "no tree grows to the heaven," does not imply that the tree falls down. The tree stays right up there and if we care for the roots and do a bit of pruning it will go right on growing next season.
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Tags: Consumers, De Beers, DTC, Economy, Jewelry, Luxury Products, Manufacturing, Production
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