"Four Digit" Gold Prices Will Remake the US Jewelry Industry

Implications: "Four digit" gold prices will make many of the products sold in today's jewelry stores almost unsaleable; forcing the industry to reinvent itself.  Here's how that might happen.

Analysis: Bad news for the $65 billion US jewelry industry and for public jewelry company shareholders, gold broke the $1,000/toz barrier and is climbing higher.  As of Monday, March 17th gold was trading for $1,011/toz up from its closing price on the previous Friday of $1,003.  During the day it had traded as high as $1,023; suggesting gold will continue to rise.  That’s likely as the Fed continues to lower interest rates, further weakening the US dollar. 

Gold and precious metals products make up 60% to 80% of the products sold by most retail jewelry stores.  Since September 12, 2001, gold has risen by more than 255%; increasing by more than 100% in the last two years. As a consequence, retailers have had to constantly reprice their merchandise to maintain margins.  Unfortunately for investors, retail price increases haven’t kept up with the pace of commodity prices, so retail jewelry sales and margins have been under constant pressure.  Large retailers like Zale and Signet recently announced they were repricing their inventory after Valentines Day.  This was a signal for the entire industry to catch up.  But it’s doubtful these price increases will be enough, since gold prices have jumped nearly 20% since January 2008.

According to one independent jeweler, a gold chain that was in stock for $189 will now sell for $346 replaced.  That’s because only a fraction of the total gold price increase found its way into the market place as many small jewelers chose not to raise prices on existing inventory.  Instead, they sold existing products at old prices; changing price only when stock was reordered.  While jewelry prices were increased more frequently by large chains, they often elected to absorb part of the increased costs to remain competitive in the market place.  This pricing disparity between large and small jewelry businesses may explain, in part, why independent jewelers have generally out performed large mall chains since 2005.  The question is:  With many retailers now passing on most of the price increase, will customers continue to buy?  -

For years jewelry retailers have clung to the belief that jewelry was a price point business.  By that I mean they thought customers expected to see product assortments built around fixed prices like $99, $149, $199, $299, $399, $499…etc.  For that reason, jeweler’s re-engineered designs to maintain these ‘magical prices’ as gold and other commodities increased in price.  To do so, they often remade jewelry styles in lower carat weight gold, designed lighter styles in terms of absolute weight, and lowered the technical quality the diamond and precious stones used in the jewelry.  After a decade of buying this type of product consumers began to recognize it for the low quality it was.  Today, millions of women have dozens of jewelry items in their jewelry box that has broken because of light weight construction, lost stones because of weak prongs, and is unappealing because of inferior quality gemstones.  This products low utility, more than anything else, has contributed to a loss of the “emotional appeal’ of fine jewelry as the quintessential gift.  That in turn has given other gift categories, such as high end electronics and travel a competitive advantage over jewelry in the battle for the consumer’s dwindling discretionary dollar.  Sadly, consumers were already buying less of the product carried by many of the mass merchandisers and mid-market jewelry chains jeweler’s at the old prices.  Now higher prices and the corresponding decline in perceived value can only escalate decreased sales in the coming months.

In effect, the jewelry industry has boxed itself into a corner.  Retailers must raise prices to maintain margins to cover escalating costs in their own businesses.  However, this time they can’t re-engineer items to reduce product costs without further eroding the consumer’s confidence in the product and driving gift givers to alternative products.  For many discounters and mass merchandisers, there isn’t a realistic solution.  These businesses stole market share from jewelry stores and department stores by selling inferior quality products at prices that were sometimes one-half that of realistic quality product.  Since millions of consumers have already begun to reject that product at the old prices, it is unrealistic to believe they will buy more of it at prices up to twice as high.

On the other hand, many mid-market jewelers, luxury jewelers, and better department stores have a solution if they choose to implement it.  For instance, they could raise prices, increase quality to a practical level of utility, significantly improve their level of service, and replace lower price points with alternative jewelry products.  Fortunately, for these retailers the technology exists accomplish this.  But, whether the industry will recognize the solution and implement it remains to be seen. 

That’s because the industry is highly fragmented with about 24,000 stores that sell jewelry in the US market.  Historically, small retailers looked for leadership from larger chains and manufacturers.  Independent chains like Zale, Gordon, and Kay worked in combination with large US manufacturers to guide the industry.  Today, the consolidation of the largest retail chains has reduced both leadership and competition in the industry and the US manufacturing base is all but disappeared. 

In contrast to the past, some of the largest jewelry chains are run by profession retailers or money managers whose knowledge of the jewelry business and business goals are distinctly different from the professional jewelers that founded the modern jewelry industry.  For instance, Zale is now managed by a veteran retailer whose business experience is primarily in children’s apparel and Disney branded products.  Three hedge funds own about 28% of Zale Corporation and have two members on the board of directors.  Zale is closing stores, cutting expenses, and reducing capital expenditure in order to maximize short term cash flow to fund stock buybacks.  Rudimentary industry knowledge and a short-term profit mentality may be good for hedge funds, but it also means the industry can’t expect much leadership from America’ second largest jeweler.  Many of the other oblivious industry leaders are similarly impaired.

Manufacturing leadership is also unlikely.  First, there are no large, domestic manufacturers to provide the leadership.  Second, many of the US manufacturers that remain are either too small to take a leadership role or are tied to large production facilities in China or India.  There they compete for new product investment with demand for local product which is growing disproportionately faster than US jewelry growth.  The fact is much of the product bought for US consumption was never designed for US consumers.  Determined to maximize short-term profits, large chains chose longer payment terms, exchange privileges, and guaranteed sales at the expense of new product innovation for the US market.  Unfortunately, many of the current buyers and retail executives can’t tell the difference, but consumers can.  That’s way many are abandoning fine jewelry as a gift to commemorate life’s most important occasions.    So the industry can’t expect much leadership from the manufacturing industry, especially the overseas suppliers.

A turn around in the industry will either come from several small chains working in conjunction with a variety of emerging, technology oriented US manufacturers or as the after effect of the break up some of the large chains.  It was small, expanding, jewelry chains like Zale and Gordon that enabled the development of mass production in the US jewelry manufacturing industry.  Pioneer manufacturers like Buster Goodman (I. B. Goodman), Henry Peterson (Feature Ring), and Kurt Wayne (Kurt Wayne Inc) working with visionary retailers such as Morris Zale, Meyer Gordon, Frank Gerstein made fine jewelry accessible to North America’s middle class in the last half of the 20th century.  Innovative small chains may be the sources of industry grow again.  For investors, Birks & Mayor and Whitehall Jewelers are two of the smaller public jewelers.  However, it is problematic whether either of these two retailers will be one of the leaders.

New growth may also come from several large chains like Zale or Signet Group PLC.  Zale, in contrast to Signet, is probably better positioned than any other chain, to provide the leadership to reinvent the industry and reinvigorate US jewelry manufacturing too. This is because Zale will most likely either be sold or further broken up since the probability of a sustained turnaround of the company under its current ownership is remote at best.  Assuming the new owner isn’t Signet, they would be highly motivated to reinvent the brand.

Off course gold prices could plummet as they did in 1980 when they dropped from a high of $835 on January 18th to $395 twenty four months later.  That continues to be what many retailers hope will happen this time.  But that was then.  Now US consumption isn’t driving gold prices higher, emerging markets overseas are creating the demand.  Economic conditions are also different, as is the structure of the gold mining industry.  While the price of gold will continue to fluctuate, market dynamics suggests that US retailers and consumers alike have seen the last of $400 gold for the foreseeable future.  It follows that successful jewelers will be those that embrace that reality and work to reinvent their businesses.  Unfortunately, there is little evidence that many of the current jewelry retailers have identified the problem, much less started the process.