Summary
For the first time in a half century diamond prices are behaving like commodities. Here why the $65 billion dollar jewelry industry is in for even more volatile times.
Analysis
As if specialty retail jewelers didn’t have enough problems, the current financial mess is forcing diamond price down. Well rough diamond prices anyway. What that will do to polished diamond prices is uncertain. However, banks were already demanding diamond firms reduce debt. Now that their very collateral is dropping in price, cutters may have to sell inventories to satisfy bank covenants.
The DTC’s says it plans to reduce the size of its sights. Sights are the venues where DeBeers sells it rough diamonds to about 100 diamond manufacturers and rough diamond dealers. However, more than 50% of the world’s diamond production is controlled by independent diamond producers. That means DeBeers has no control over the amount of rough diamonds they sell or the prices they sell for. Moreover, governments of diamond producing countries have huge incentive to sell as much diamond production as possible in the black market since they depend on mining income for a large portion of their GDP and hard currency.
What does this mean to specialty jewelers? Short term, most retailers will hold prices even if replacement costs for both gold and diamonds decline. Lower cost polished diamonds won’t be available until after Christmas. But that begs the question of pricing year end inventories and remaining competitive as lower priced goods become available. Large chains in particular have problem since they buy in bulk and often months in advance.
Then there are those jewelry chains that have an interest in diamond production or diamond manufacturing. These companies face huge losses if rough prices decline. For instance, analysts have recently downgraded Harry Winston (HWD) because of its stake in Canadian diamond production. Last, there are those large chains that may have price agreements to buy loose diamond production from large cutters.
Longer term lower diamond prices could mean lower price points for consumers and that is exactly what they want. It also means, less revenue for stores, since lower price points equals less turnover per store unless demand increases which isn’t likely to happen so long as credit is tight. Large chains and independents rely on in-house or 3rd party credit for about 30% to 55% of their sales. Then there is the issue of lower bank card limits.
Another more subtle issue is the effect lower diamond prices will have on the public’s perception diamonds. DeBeers has spent hundreds of millions of dollars during the last 50 years cultivating the image that a diamond’s value is forever. It has become the quintessential luxury gift. Now that the product is more commodities like, it remains to be seen if both men and women’s emotional attachment to the product will be undermined.
Clearly, the jewelry industry is in for some volatile times. Large chains like Signet and Zale have increased average store sales significantly over the last decade and along with it their overheads. Occupancy costs that average 7%-8% of sales when turnover exceeds the breakpoint that can escalate to 12% to 15% of sales if turnover declines to where fixed rents kick in.
Then there’s that huge body shop composed of area managers, district managers, regional managers, vice presidents and their support staff that manage store operations. Such costs are essentially fixed and quickly deleverage profits as sales decrease. Last, there is the diamond factor. Large chains frequently depend on diamond product for 40% to 70% of sales and often an even larger percentage of their profit.
Demand was already declining for diamonds before the banking crisis, now falling diamond prices could accelerate that decline if new buyers begin to view diamonds as commodity. All the while DeBeers has significantly decreased their advertising spend in the
