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26 October 2016

Market outlook for diamonds

The Energy & Natural Resources Group hosted a breakfast seminar last week, exploring the short and longer term outlook for the diamond market, with a particular focus on China.

The seminar featured a presentation from guest speaker Alison Turner, founder of Broadhurst Mining Research. Alison was able to provide expert opinion formulated through more than 13 years’ experience analysing mining markets and evaluating mining projects.

The key message of the presentation was that the short and longer term outlook for the diamond market varies significantly, with longer term projections providing a positive comfort to some short term concerns.

Demand for diamonds is dominated by the US and Chinese markets, which together make up 61% of worldwide demand. Whereas US demand, at 45%, remains relatively stable, China has been and remains a far greater swing factor.

Short term challenges

Alison was able to explain that the short term challenge for the diamond market results from the fall in demand for jewellery in the current Chinese market. The rapid growth of the Chinese economy allowed for increased demand amongst the emerging middle class and High Net Worth Individuals (HNWIs) for diamond jewellery. This increased demand was reflected in the rapid expansion of Chinese jewellery stores and significant increases in their inventory. Between March 2010 and March 2015, jewellers increased diamond inventories by US$3.2bn, to cUS$5.8bn, but this increase was not seen to be a problem as all indications suggested a continued growth in sales.

However, as inventories grew demand began to decline; Hong Kong and Macau particularly and parts of mainland China have seen significant falls in same store sales and are now facing slowing rates of store openings and even store closures. Rather than purchasing inventory for new stores from diamond suppliers, inventories can be transferred from closed stores to new openings, leaving a significant supply-side overhang. Using Chinese jeweller store Chow Tai Fook as an example, Broadhurst estimated that the average diamond spends 760 days at the jeweller before being sold, suggesting that further significant inventory reductions are needed.

Overall, Broadhurst estimates that in the year to March 2016, Chinese jewellers reduced diamond inventory by US$744m, reducing world apparent diamond demand by 3%. In the coming year, they expect Chinese jewellers to reduce inventory by a further US$650m – a drag on world demand of c2.6%.

Longer term prospects

The short term challenges for the diamond market then, particularly in China but reflected worldwide, could be expected to cause investors some concern. However Alison was keen to stress that this fall in diamond demand will not continue into the longer term period, driven by positive fundamentals:

  • the growth of the middle class;
  • the growth of HNWIs; and
  • The growth of the middle class

Whilst diamond demand growth in China has slowed since 2010, the Chinese middle class has continued to grow strongly in terms of numbers and that growth is expected to continue albeit at a slightly slower rate. Whilst the US is still the major player in the diamond market, the Chinese middle class has now overtaken the US in terms of numbers and Broadhurst forecasts 5% annual growth through to 2020 (versus 1% in the US). It is estimated that 75% of the Chinese middle class only attained that level within the last ten years. As wages continue to rise amongst this emerging middle class and they adapt to their new financial position this should see an increased desire and ability to ‘splash out’ on gifts, such as diamond jewellery.

The growth of HNWIs

Broadhurst noted that in India (according to a De Beers survey), 40% of all diamonds by value are sold to the super-elite which illustrates the fundamental importance of HNWIs to the diamond market. Whilst China’s middle class has overtaken the US in terms of numbers, this has not been the same with HNWIs. For every 35 middle class citizens in the US there is 1 HNWI, whereas in China the ratio is closer to 190:1, but they are catching up. In the last 3 years China has seen a 17% increase in HNWI numbers.

Cultural desire

China has also experienced a significant cultural shift in recent years. As China has slowly opened itself to the West, the younger generation have grown up exposed to Western influence, such as the desire for luxury goods. According to the De Beers Insight Report 2016, Chinese ‘Millenials’ (currently aged 15-34) were responsible for US$6.8bn (or 68%) of the total diamonds purchased in China, despite making up only 31% of the population.

Since 1994, the percentage of Chinese marriages celebrated with a diamond has increased from 1% to 48%, a trend Alison predicts will continue.

Conclusions

Alison’s fundamental message is that whilst the diamond market appears to be facing a period of short term difficulty, investors should not panic and should expect to see the demand contraction reverse next year and lead into an exciting period of growth in the coming years.

In the short term, investors should be cognisant that three new mines are set to ramp up over the next 6 months adding c5% to world supply. The price impact of that additional supply may be exacerbated as the planned ramp up coincides with weak demand and inventory reductions in China. However, as the market stabilises there is a far more positive longer term forecast for the diamond market. China is predicted to see the greatest growth, due to the demographic reasons outlined above, with demand forecast to increase by 5.5% p.a. in the years 2015-2020, driving a 3.6% p.a. growth in worldwide diamond demand.

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