Diamond Sector May See a Slow First Half

The diamond industry could see a slow and challenging first half this year with rough and polished prices remaining fragile as well as volatile, and dependent upon growth from consumers in Asia and the U.S., RBC Capital Markets said in its 2012 Diamond Sector Outlook report.

The report noted that sales figures of the major jewelry retailers at the end of 2011 showed that Asia remains a relatively bright star in the diamond firmament, but in the U.S., the largest global market for diamond jewelry, sales were “somewhat disappointing,” though not in all parts of the country.

RBC said its quarterly visit to Antwerp saw the cutting center quiet and somewhat apprehensive about the first quarter. “Diamond cutters, polishers and dealers say rough prices have recovered from the lows of July and August last year, but business is slow,” analyst Des Kilalea wrote in the report. “Most expect no material let up until mid-year.”

However, rough diamond prices, while experiencing steep declines during the third quarter of 2011, are likely to see a gradual improvement throughout 2012 provided world recession can be avoided, he noted. The report said that the bottom has been passed for rough prices, but sustainable strength will not be possible unless De Beers and ALROSA are restrained and until the U.S. market picks up.

RBC stressed that the pace of recovery in the rough market will be determined by three factors: How Christmas diamond jewelry sales converted into cash-flow at the cutting centers; how aggressively De Beers and ALROSA sell rough, particularly in the first part of the year, and the level of bank debt in cutting centers and the industry’s ability to fund the rebuilding of inventory.

“Should both companies restrain sales in (first half of 2012), it will help the diamond sector regain confidence after the knock to profits in Q3 (third quarter of 2011) when rough prices fell sharply,” the report said.

A weaker rupee is also a cause of concern for the Indian cutters. “With large debts, sometimes in the U.S. dollar, and receivables hedged at strong exchange rates, we believe many companies in India will be hard pressed to aggressively rebuild inventories,” RBC said.

Nonetheless, most diamond miners still believe that the second six months of the year will see better prices, the report said.

“The long-term outlook for the sector, however, remains good in our view with limited new production ahead and growing demand for jewelry in Asian markets bolstering the large U.S. market,” RBC projected.

The report said that several diamond companies will probably look to the debt and equity capital markets to fund projects over the next year or two. However, the market is likely to remain “closed” for the companies looking to raise new capital until there are signs of improved conditions in rough and polished prices.

“We believe this is likely to lead to more consolidation in the sector and for unconventional funding arrangements ranging from more debt to supplier credits and offtake agreements,” RBC analyst said.

RBC said it continues to favor companies such as Petra Diamonds, Harry Winston Diamond and Gem Diamonds, which are in production, and those near to development and in a position to raise finance, such as Stornoway Diamond.

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