'Party over for diamonds'

That's the conclusion reached by RBC Capital Markets analyst Des Kilalea who said in a recently published research report that "after two years of strongly-rising prices, the party is over for diamonds - at least for the next year or two".

Following a visit to the key diamond cutting and trading centre of Antwerp, Kilalea reported that "boxes" of diamonds bought at De Beers' September sight were trading at discounts of 5% to 7%.

Bargain boxes

"This is possibly the first time in 10 sights that the boxes have traded at discounts as, in a rising price environment, the boxes have been trading at premiums," he said.

Kilalea quoted Antwerp diamantaires predicting falls in the prices of better quality and investment category diamonds of between 20% and 30%.

He added an important indicator on the price trend will be the outcome of the closed tender sale carried out by Gem Diamonds of production from its Letseng mine in Lesotho.

"Gem reported average prices from Letseng of $2 500/carat in the six months to end-June 2008. Any material fall in Gem's prices would be read as a negative for all diamond stocks."

Kilalea said: "The impact is likely to mean that diamond companies will not post the same revenue increases as forecast, while costs will remain under pressure given still-high power prices and wage inflation in producer countries.

"We believe the investment implications are worrying for the diamond sector, particularly for smaller companies which do not have sustained production and positive cash flow.

"These companies are likely to see capital raising opportunities, which are already limited, shrink further," he said.

Kilalea also highlighted the deteriorating financial situation in the cutting centres, where debt has soared from about $6bn in 2000 to about $15bn.

He pointed out there could be serious implications for the trade from the partial nationalisation of Fortis, an international provider of banking and insurance services, by the Benelux governments.

Diamond Bank sale on cards

Fortis controls the ABN Amro Diamond Bank which provides about $3bn of credit to the diamond industry.

Kilalea said: "While there is no suggestion that there is anything toxic in this book, slower demand for diamonds in jewellery and lower prices could slow the recovery of debts.

"More importantly, given ownership uncertainty, in our view it is highly unlikely that ABN, or the other major banks, will grant credit without security such as quality, third-party receivables.

"Liquidity in the diamond sector is likely to be severely constrained, at least until the ownership of ABN Amro Diamond Bank is clear, and the trend in diamond prices is better understood.

"We expect Fortis will likely sell the Diamond Bank, at a loss, but as yet no potential buyer has been named."

The end result of all this was that the widely anticipated shortage of rough diamonds within the next three to five years could be pushed out.

Kilalea said: "It is likely there will surpluses rather than shortages of rough and polished in the next year or two, as economic growth slows or retracts and liquidity dries up.

"There is also a prospect that there could be some recycling of diamonds, particularly diamonds sold as investments which could lose value, or diamonds bought by wealthy individuals who face major margin calls."

Turning to the diamond producers, Kilalea said the next 12 months would be difficult with a real prospect that margins on sales would slip.

"Add to this the difficulty of raising new money for exploration and capital projects and sharply higher risk premiums in equity markets, and it appears that the only shares which could perform on a relative basis will be those with production, preferably growing production, and positive cash flow.

"Even these will struggle to perform in our view. The list is short, covering the likes of Gem Diamonds and Petra Diamonds," he said.

- Miningmx.com

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