The weakening demand for diamonds which resulted in the decrease in rough diamond sales in 2015 has provoked concerns on how much Botswana is likely to be hit.
Figures coming from De Beers as cited in its year end financial report for the year ended 31 December 2015 indicate that sales plummeted significantly following the decision to pull back on production. The sales dropped from 33 million carats in 2014 to 20 million carats in 2015, reflecting a 39 percent decline. But South African Afena Capital senior analyst and portfolio manager Shoaib Vayej who engaged the media at the Afena press meeting recently highlighted an aspect about diamonds that is often swallowed up by the inherent vulnerability that they possess.
Diamonds, according to Vayej, are a “relatively defensive commodity which exhibit less volatility.” He said diamonds are robust fundamentals in comparison to other commodities citing two reasons to that regard. The first reason is that diamonds are a late stage commodity meaning their consumption tends to increase as the country advances in its economic development. In other words, consumption increases as the country’s Gross Domestic Product (GDP) per capita increases. The second reason is that the consolidated nature of their supply cushions the impact of a slowing demand, as was observed last year. This allowed producers to scale back on production and take a portion of the stock pile into their balance sheets hence preventing a severe price response that was seen in other commodity markets.
Besides the nature of diamonds, Vayej also pointed out that the regulatory and operational strengths in Botswana’s mining sector absorbed the impact of the market drag. This defensive nature of diamonds does not however make them immune to the weak appetite demonstrated by consumers; it could only mean that it cushions the impact of a subdued diamond sector.
In explaining how impact is carried through within the sector Vayej highlighted that issues experienced at the bottom of the stream on the consumer’s end magnifies changes that take place in the upstream on the producer’s end. Diamonds’ value chain is divided into three stages, the upstream which represents the mining of rough diamonds, the midstream which represents diamond cutting and polishing activities and the downstream which represents consumption of diamonds. The manner in which the downstream feeds into the upstream was described by Vayej as the “bullwhip effect.”
De Beers’ year end financial report proves that the bullwhip effect did take place in the past year, “weaker than expected consumer demand in 2015 resulted in retailers reducing their demand for polished diamonds from the midstream manufactures. A build up in polished stocks in the midstream put downward pressure on polished prices, and reduced the midstream’s willingness to purchase additional rough diamonds,” it cited.
Looking to the future, the report highlights that rough diamond demand in 2016 will be dependent on consumer demand for diamond jewellery and the resultant levels of restocking required by retailers. De Beers responded to the weak demand by cutting back on its prouction but Vayej pointed out that its effect is constrained because other producers did not follow suit in adjusting production, citing for example that Alrosa is sitting on a 24 million carats stockpile. The impact on rough producers, as he indicated, is the potential of a prolonged weak cycle “because of large inventory overhang even when demand recovers.”
As a solution to the current diamond downside, particularly in the midstream sector, Vayej said there is urgent need for consolidation so as to restore profitability. He also said transparency is critical given the high risk that banks and other financial institutions place on the industry. The current reality, he says, is that too much debt is being shouldered by the midstream which will be a painful process to navigate.
Despite the pain that the diamond sector will experience before demand fully recovers Vayej expressed confidence in Botswana holding it together. “I believe that Botswana mines are well placed, one because they’re efficiently managed and together with natural endowment means they quite low down the cost curve or higher the margin curve. They are defensive in a downside cycle which gives producers confidence to continue re-investment,” he said.
