Paul Zimnisky: 2018 Global Diamond Industry Primer

by: Paul Zimnisky

Through mid-December 2017, rough diamond prices are up 2.7%* year-to-date, while polished prices are down 3.5%**. However, despite shrinking manufacturer margins, the midstream segment of the industry still bought $5.3B worth of diamonds from De Beers this year, including $450M at the final sight which was 7% over the comparable sight last year and 81% over 2015.

De Beers' full-year sales were -5% relative to last year and +53% over 2015. Russian-major, ALROSA (MICEX: ALRS), is on pace to sell $4.4B of diamonds in 2017, which would be in line with 2016 and 27% over 2015.

2017 has been a year of excess inventory shifting from the upstream segment of the diamond industry to the mid-stream segment. For instance, industry leaders De Beers and ALROSA have both see their inventories decrease by an estimated 1.6M and 2.3M carats, respectively, through Q3 2017, this despite both producers also increasing production this year.

World-wide natural diamond production is estimated to rise to approximately 148M carats in 2017 which would be a 7% increase in volume over last year. The increase mostly due to the commencement of production at three new mines, the ramping-up of production at previously curtailed operations and expansion projects at legacy mines.

Chart of rough and polished diamond price spread in 2017. Source: Paul Zimnisky

Despite various operating setbacks and political challenges that have disrupted production at multiple mines this year, including an accident that has since halted production at ALROSA's Mir mine, most major miners are still on pace to produce towards the higher end of guidance ranges.

Most industry participants would agree that the first half of 2017 was strong, however, the second half relatively disappointing. Demand for rough returned aggressively in early-2017 as manufacturers in India recovered from the late-2016 liquidity crisis caused by the government's demonetization of high denomination bank notes.

However, by mid-year, new polished entering the market compounded an already overstocked global polished inventory and manufacturers noticeably pulled back operating activity punctuated with longer-than usual Diwali factory closures in the fall.

In recent weeks manufacturer activity has begun ramping up again, as the industry prepares to replenish Christmas and Indian wedding season stock and deliver for Chinese New Year demand.

The U.S. consumer market is currently supported by a relatively strong economy. With the stock market regularly making new all-time highs and with most employment figures at favorable levels, consumer sentiment is positive. Pending tax reform and the recent appointment of a new Fed chairman that favors continued dovish policy has supported this trend.

America's largest jeweler, Signet Jewelers (NYSE: SIG), had a challenging 2017, however most of underperformance can be attributed side effects associated with the company restructuring, and not necessarily the appetite of the U.S. consumer. In fact, globally-diversified Tiffany & Co. (NYSE: TIF) recently noted the U.S. market as one of its strongest.

A Luk Fook storefront in Macau. Source: Luk Fook Jewellery Group Ltd.

Tiffany also noted particular strength in the company's Mainland Chinese market. Recent results from leading Greater China jeweler, Chow Tai Fook (HK: 1929), supports this as the company has seen same-store-sales growth for four consecutive quarters in its Mainland market and three consecutive quarters in Hong Kong/Maccu.

Luk Fook (HK: 0590), which has a greater exposure to Hong Kong than Chow Tai Fook (which is more Mainland focused), had same-store-sales growth of over 11% in the six-months ending September 30, which stands out against three prior comparable years of decline.

On November 21, Chow Tai Fook described the current market as a "turning point...given the nascent jewelry market recovery" and Luk Fook has recently described the climate as "improved."

The U.S. is still by far the largest end-consumer market for diamonds at about 50%. Greater China, which includes Mainland China, Hong Kong, Macau and Taiwan, and India represent the industry's fastest growing large markets.

Global diamond supply is estimated to marginally decrease about 1.5% in 2018 to 146M carats and global polished diamond wholesale demand is estimated to hit $26.6B next year, which would be a 3.8% increase over 2017.

Heading into 2018, here are some possible diamond industry catalysts to watch for:

Indian billionaire Anil Agarwal who has a fond interest in diamonds and is now the largest shareholder of De Beers' parent Anglo American (LSE: AAL) after accumulating shares throughout 2017, could make a move to gain control of the company in 2018 Next year ALROSA will decide whether to rebuild or close the Mir mine after it sustained a flooding accident in August 2017; a decision to permanently close the mine would be supportive of global supply/demand dynamics, e.g. the loss of Mir production would offset the combined new supply from Renard and Liqhobong (two of the three mines that commenced production this year)

The Mir underground mine in Russia. Source: ALROSA

In December Tiffany & Co. stock rallied to just shy of an all-time high in part due to takeover speculation, an event that could possibly play out in 2018 as favor for international luxury returns Lucara Diamond Corp (TSX: LUC) is back to mining fresh South Lobe ore, the portion of the Karowe ore body that produced the Lesedi La Rona and Constellation diamonds; with a new advanced large-stone recovery system in place, Lucara has the potential to produce more newsworthy diamonds in 2018Signet Jewelers could recover after a disappointing 2017 as company-wide restricting plays out, including selling its customer credit portfolio, closing underperforming mall-based stores, expanding at off-mall locations, integrating web and digital into sales strategies, and executive level changeZimbabwe's government-run ZMDC (private) has commenced conglomerate mining at the Marange fields with $30M of new equipment which could increase production in 2018 to an estimated 3.5M carats from just over 2.0M carats in 2017De Beers' Voorspoed mine in South Africa, Gem Diamond's (LSE: GEMD) Ghaghoo mine in Botswana, and previous-Rio Tinto (LSE: RIO) diamond project, Bunder, are all up for sale and could have new owners in 2018As production at De Beers' and Mountain Province Diamonds' (TSX: MPVD) Gahcho Ku?(C) mine approaches deeper depths in 2018, more production could come from center-lobe ore which is expected to be of lower grade but host higher-quality diamonds Kennady Diamonds (TSX-V: KDI) and Peregrine Diamonds (TSX: PGD) both disclosed that they had been in discussions with potential strategic partners in 2017, an indication of possible deals in 2018Stornoway Diamonds' (TSX: SWY) waste sorting circuit which is being installed to alleviate diamond breakage during processing could prove effective when it goes live in Q2 2018, the likely result being a higher average diamond price achieved for Stornoway's Renard goods

The Karowe mine in Botswana. Source: Lucara Diamond Corp

Following a disappointing 2017, mining of lower grade areas at Firestone Diamonds' (LSE: FDI) Liqhobong mine nears completion and production is expected to move to areas of the open pit that host higher quality diamonds in 2018A review of the proposed South African Mining Charter will take place in mid-February 2018, which could have implications on ownership and operations of diamond companies in the country including De Beers and Petra Diamonds (LSE: PDL)Further work at Luaxe in 2018, arguably the most important undeveloped diamond project in the world, could provide further clarity on resource and production details and a production start date, which is now anticipated for some time after 2020A continued weaker U.S. dollar in 2018 could support momentum in global consumer luxury demand, while a shift in trajectory could have an adverse effectAn updated feasibility study on Shore Gold's (TSX: SGF) Star-Orion South project in Saskatchewan Canada, is anticipated in 2018, which could change the economics of the project by reducing an almost $2B pre-production capex

Rough diamond sample from the Star-Orion South project in Canada. Source: Shore Gold

North Arrow Minerals (TSX-V: NAR) is expected to set up an exploration camp and drill its Mel property in 2018, the site of Canada's newest diamond discovery, which could further indicate the significance of the discovery Lab-created diamond production expected to continue to increase in 2018, however wider-consumer appetite for the product is still unclear and production of larger gem-quality stones is still just a fraction of the natural equivalent productionDunnedin Ventures (TSX-V: DVI) has plans to conduct the company's first drill program in 2018 at its Kahuna project in Canada's Nunavut territory which could result in a new discovery near Agnico Eagle's (TSX: AEM) Meliadine gold mine currently in developmentLucapa Diamond (ASX: LOM) expects to commence production at Mothae in Lesotho in the second half of 2018, a mine with the potential to produce diamonds worth in excess of $1,000/ct on average The Diamond Producers Association, established by the diamond industry to return generic marketing to diamonds, could impact consumer demand following the launch of a second U.S. campaign and first Indian campaign in November 2017 and first Chinese campaign in April 2018 Five Star Diamonds (TSX-V: STAR) plans to continue progressing exploration and development on over 20 kimberlite projects in Brazil in 2018, which could lead to Brazil eventually becoming a more important contributor to global diamond supply U.S.-based lab-created diamond producer, Diamond Foundry (private), plans to build a "MegaCarat foundry" in Washington state, with first reactors expected to be deployed by Q2 2018, which would add to the company's current annual production estimated at approximately 100k carats

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*Rough diamond price based on the Zimnisky Global Rough Diamond Price Index. More information can be found at www.roughdiamondindex.com. **Polished diamond price based on data gathered via sampling of online retailers, specifically round, 0.5-1.5 carat, near-colorless, VS-clarity, VG-cut diamonds.

All figures in U.S. dollars unless otherwise noted.

De Beers is 85% owned by Anglo American plc and 15% owned by the Government of the Republic of Botswana.

At the time of writing the author held a long position in Lucara Diamond Corp, Stornoway Diamond Corp, Mountain Province Diamonds Inc, Kennady Diamonds Inc, Tsodilo Resources Ltd, North Arrow Minerals Inc, Signet Jewelers Ltd and Peregrine Diamonds Ltd. Please read full disclosure below.

Paul Zimnisky is an independent diamond industry analyst, author of the Zimnisky Global Rough Diamond Price Index and publisher of the subscription-based State of The Diamond Market monthly industry newsletter. In 2018, he will be speaking at Mining Indaba in Cape Town, South Africa on February 6, and Mines and Money in New York on May 9. Paul can be reached at paul@paulzimnisky.com and followed on Twitter @paulzimnisky.

 

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