Diamond industry financing has considerably declined over the last couple of years. Generally, the industry views this as unfavorable; yet, this can be debated. What is not in debate is that right now the diamond industry’s debt level is at its lowest in well over a decade.
Currently, diamond industry financing is estimated at around $9 billion. According to our estimates, industry indebtedness averaged $9.7 billion in 2019, with a downward trajectory throughout the year. That includes bank-supplied credit and money supplied by other financial entities such as investment firms and insurance companies.
With some fluctuations, the downward trajectory is not unique to this past year. It is a drawn-out process that goes as far back as 2011. Although money and credit supply bounced upwards in 2014, it has since withered. It hasn’t been since 2004, 15 years ago, that industry debt has been so low. This is a healthy sign, as I will show.
Diamond Industry Financing or Diamond Industry Debt?
One could argue that asking if we are talking about diamond industry financing or debt is just a question of semantics, two sides of the same coin. Clearly, bank financing is the engine behind an industry’s growth – any industry. Silicon Valley could not have become the shining success story of the past few decades without VCs, IPOs, and other sources of financing.
With a large inventory in declining demand and a drop in inventory value, credit suppliers start calling in their money.Yet at the same time, financing can sometimes become a double-edged sword in the hands of those who don’t wield it well. An over-leveraged, heavily indebted diamond industry is vulnerable. Solid consumer demand for diamond jewelry in 2010 triggered a sharp rise in demand from Chinese and Indian retailers, starting in early 2011. This led to a rise in polished diamond prices and naturally translated into rising rough diamond prices, as the midstream shifted into a buying, manufacturing, and wholesaling frenzy to satisfy demand.
At the time, Standard Chartered Bank poured a massive amount of money into the diamond midstream. It seemed that everyone in the midstream was making a killing. But the extra financing only fueled price hikes. It did not contribute to R&D, added value, or sustainable growth. The price hikes were a price bubble, of course, and polished prices started to nosedive in July 2011. With them, diamond industry financing started to contract. Polished diamond prices have been heading south ever since.
Worse, with a large inventory in declining demand and a drop in inventory value, credit suppliers start calling in their money. That hurt the industry immensely and led to a round of business failures.
Rising Diamond Industry Financing Leads to Rough Price Hikes
It was said before, but should be reiterated. As diamond industry financing rises, so do rough diamond prices. When financing contracts, rough diamond prices decline. The correlation is rather direct. The infusion of money in 2010–2011, as well as in 2014, had a direct impact on rough diamond prices.
The drop in rough diamond supply and the recent decline in prices freed up a large chunk of money, a “savings” in excess of $3 billion on rough purchases in 2019 alone.The issue is not if this happens, as much as its impact. When financing becomes less available and declines, rough diamond prices don’t shrink as quickly with it. This is the real price of financing-motivated price hikes. It is very difficult to convince miners to reduce prices when inventory piles up and sales are falling. It is even tougher to do so when the issue is decreased access to financing.
There are those who will argue that this is impossible and for good reason: it is a fantastic process for forcing market consolidation. Traders in Belgium and Israel lamenting on the “unfair advantage” Indian traders have, expressing a deep wish they had access to the kind of financing their Mumbai-based counterparts do, should keep this in mind. Simply consider the ratio of business closures in India and compare it to Belgium and Israel. That alone tells you the dangers of greater access to money.
Is There a Shortage in Diamond Industry Financing?
The underlying issue is that higher rough diamond prices require higher polished diamond prices (but only if you want to maintain margins). With consumer push-back so intense, is an infusion of credit the solution to the current low? In theory, if the industry could hold back on the urge, the extra money could be used for marketing. But who are we kidding? The urge can’t be resisted. Extra cash is always used to leverage position, meaning to rush out and buy rough.
In fact, the industry at large found that self-financing provided what it needed. As one astute trader pointed out, the drop in rough diamond supply and the recent decline in prices freed up a large chunk of money, a “savings” in excess of $3 billion on rough purchases in 2019 alone.
Considering the cut in overhead from manufacturing reduction, and the sharp decline in financing this year, it seems almost like a bargain for the midstream.
In reality, the reduction provided the diamond midstream with a golden opportunity to put many affairs in order, including driving efficiencies and bidding farewell to those who did not rise to the occasion and dropped out of the business.
What will Future Prices of Rough Diamonds Look Like?
The future prices of rough diamonds is up to suppliers – rough and credit suppliers, that is. If financing remains at current or similar levels, and the inventory drainage continues, a paced supply of rough diamonds will allow a healthy growth trajectory for the midstream.
A more likely scenario is that miners will restore prices and sales as soon as possible. Will financing suppliers be tempted to increase financing to the diamond industry midstream? Probably. Let’s just hope that in an era of cheap money, they will do so as cautiously as possible.