HomeFeatures & AnalysisDiamonds – an attractive investment?

Diamonds – an attractive investment?

South Africa’s 2016 first quarter results for the mining sector was one of the worst the sector has ever experienced, shrinking by 18% year-on-year from March 2015.

The worse performers in mining production are:

  • Copper production down 38.3%
  • Metallic minerals down 24.3%
  • Platinum group minerals down 23.7% and
  • Iron ore down 12.4%

When looking at South Africa’s diamond production, the sector produced 18% less year on year. In the first two months of 2016, mining production was already down by 7.1% and entering into a seasonal downturn.

The major factors that have led to this dramatic shrinkage are weak Chinese demand, weak commodity prices, low business confidence, sluggish global growth and large depreciation in the rand against the US dollar.

This does not allow South Africa to take advantage of lower oil prices, which is an input cost and increasing interest rates making financing costs more expensive.

This immense pressure had a ripple effect and has pushed mining conglomerate, Anglo American (85% owner of the De Beers Group) to implement a divesting strategy, moving away from its previous diversification approach.

Anglo American is planning to focus its core business on three mining sectors – copper, platinum and diamonds and will be selling many of its non-performing assets.

The diamond sector employs approximately 12 000 workers, 50.1% are miners and in addition to this 31% are sub-contracted mine workers. The diamond division contributes 20% to Anglo’s consolidated revenue.

Over the past three years the diamond industry as a whole has been under-performing, leading to the overall prices of diamonds decreasing. Between 2014 and 2015, the prices of rough diamonds decreased by 8% and polished diamonds decreased 15%. Overall demand for rough diamonds in 2015 decreased by 12% and for polished diamonds decreased by 23%.

However, working from a lower base in 2016, the industry began recovering with sales of rough diamonds equating to $3.1 billion in April 2016. These sales, accounted by ALROSA and De Beers, showed an improvement of 18% but are still 13% below comparable 2014 figures.

February 2016 saw the first price increase of rough diamonds by De Beers of 2% since the last quarter of 2014.

The reason for the overall weaker performance in the diamond industry is attributable to the following factors:

  • Weak Chinese demand
  • Withdrawal of lenders (financial institution) to cutting and polishing manufacturers
  • Failure by producers to immediately react to the decrease in demand.

Viewing diamonds as an investment opportunity

The US markets have substantially increased demand for polished diamonds, accounting for 42% market share. The interesting point is that the US increased demand for bigger carat diamonds, 1 carat and above, but imported less of the lower carat and value diamonds.

In the UAE, China and India demand for lower and cheaper carat diamonds increased. At face value this looks like the norm for the USA to think bigger is better.

However, when exploring the investment return of $1 000 over a 10 year period of higher carat diamonds, there seems to be an underlying factor.

It is interesting to view the relationship between the value of gold and diamonds during 2008 – 2012. During this period the global economy was experiencing its worst global recession. As a norm during periods of uncertainty investors normally flock to gold as a safe haven.

However during the same period the value of diamonds, especially the higher and more expensive carat diamonds like the 5 carat diamond followed a similar pattern as gold.

Because gold has a longer history for investors as a safe haven, more investors tends to invest in gold compared to diamonds. Gold averaged at a price of $2 548.2 and the 5 carat diamond averaged at a price of $1 992.2, compared to the average price of the NASDAQ and Dow Jones, $1 099.4 and $1 047 during 2008-2012 respectively.

This illustrates that higher carat diamonds can be utilised, with gold, as a hedging instrument and safe haven during periods of uncertainty. The 1 carat diamond reacted in a similar way.

The interesting aspect about the 5 carat diamond when compared to gold is the average return and the volatility attached. Over the 10 year period, the average returns for the NASDAQ and Dow Jones are $131.50 and $65.30 compared to gold and 5 carat diamond, $108.50 and $98.70.

The risk aspect between gold and diamonds should be carefully viewed by an investor. This is by no means saying that diamonds should replace gold. However this does show that there is a place for higher carat diamonds in the investment world as hedging tools and safe havens.

Developments in the diamond industry

The ALROSA 2015 stockpile accumulated to 22 million carats worth $2.5 billion and are planning to reduce production by 5 million carats and focus on selling their stockpile in 2016.

De Beers’ 2016 production forecast are 26-28 million carats with more emphasis placed on the Venetia diamond mine, converting South Africa’s biggest diamond mine into an underground mine to extend production by 22 years to 2043.

The growing middle class of India and China is the target market for the diamond industry. Rio Tinto’s Argyle mine in Australia is on track to exhaust resources by approximately 2020/1.

In anticipation that Argyle mine will be exhausting its resources, renewed emphasis has been placed on the North-East of Angola. The Development Bank of Southern Africa (DBSA) has already approved $262 million to Zambia for infrastructure development.

This “North-South Corridor” initiative will link the Durban port of South Africa with the port of Dar es Salaam. Further development to the west of Zambia will link these road channels, linking South Africa to the north-east of Angola.

This will allow South Africa to gain access to the North-East regions of Angola where it is hard to reach and explore diamond operations. This will have more rewards for countries like Zambia, Angola and Tanzania.

Online sales of diamonds are forcing retailers to strategise as more clients are researching their purchase before buying a diamond. No longer are buyers walking into jewellers to obtain information on what to purchase at what price. They are now more knowledgeable and negotiating is known as the “click and mortar”.

Nano diamonds are being researched by the biological and medical field to be utilised in providing cancer patients with the necessary chemo therapy in extremely hard to reach and dangerous areas, like tumors in brains. The chemical structure of diamonds does not release toxic emissions in humans and is small enough to pass through the blood brain barrier.

Melbourne University researchers are attempting to utilise diamonds in solar panels to collect extra electrons released through Thermionic emissions to increase the efficiency of solar energy collection. This may in the longer-term increase demand.