Diamonds are forever changed

Summary: Diamonds are being commoditised like never before, thanks to modern technology.

Key take-out: Investors in diamond miners, and diamonds themselves, might want to rethink their exposure.

Investing in diamonds, whether in their gem form or in the shares of a diamond mining company, has become a lot trickier in the three months since Eureka Report last looked at one of more exotic commodities.

Back in that original story (Diamonds out of the rough, July 13) diamonds were performing strongly, thanks to rapid growth in the major jewellery markets of the US and China, but since then a series of events have clouded the outlook.

The trade war is an obvious negative for diamonds, which are very much an item of discretionary spending, but the bigger influences are likely to be much longer lasting than an economic dispute between countries.

Laboratory-grown diamonds, once dismissed as second-grade material which would never threaten the real thing have reached the market, and not from any backyard operator. In fact, the chief promoter of low-priced, startlingly high-quality gems, is the biggest and oldest player in diamonds, De Beers.

Lightbox, the lab-grown arm of De Beers, has arrived with a bang, selling out of some items in the first few days of being offered via the website https://lightboxjewelry.com/, with prices that have stunned the global jewellery industry.

A pair of white solitaire diamonds studs weighing half-a-carat each is available for $US1000 and a half-carat pink solitaire pendant is on sale for $US500.

Traditionally, diamond prices can vary enormously because of varying quality in mined gems, but what Lightbox/De Beers is offering are perfectly-formed gems. Consumers and professionals alike cannot tell from the real thing without the use of specialist equipment – and even then, the conclusion is that a lab-grown diamond really is a diamond.

As if the launch of Lightbox is not a big enough threat to the traditional diamond business, an arm of the US Government has weighed in to the debate surrounding mined and man-made diamonds.

Diamonds are diamonds

The Federal Trade Commission, which is the US equivalent of the Australian Competition and Consumer Commission, has decided that diamonds, whether natural or man-made, are just that, diamonds.

The word natural has been removed from the definition of diamonds by the FTC in a move which recognises that lab-grown diamonds are identical to the mined product. That’s because all diamonds are a collection of carbon atoms arranged to maximise their reflection of light – whether they come out of the ground or a machine.

De Beers’ launch of Lightbox last week, and the FTC guidance document published on July 24 (shortly after our last diamond story) are significant developments in a business which relies on mystique and a perception of scarcity for generating value.

What magnifies the importance of those two developments is increased concern about the supply of mined diamonds as some of the world’s biggest mines reach their use-by dates. In theory, this ought to be a huge positive for prices if not for the fact that a man-made source of diamonds is moving to fill the gap – with what look like very low prices.

Mining loses its sparkle

The next few years will be critical for the diamond industry as big mines are closed. Rio Tinto’s Argyle project is scheduled to cease mining in 2022 and the company’s Diavik mine in Canada has a 2024 closure date pencilled in. Russia’s Jubilee mine ends operations in 2020 and the once giant Mir mine looks unlikely to re-open after being flooded.

Losing existing mines, and a failure to discover major new sources of diamond, means that over the next four years the supply of mined diamonds is expected to fall sharply.

Morgan Stanley, an investment bank, estimates that last year was the peak for mined-diamond production at 150.8 million carats, and this year will see output dip to 146.7 million carats. That decline, plus steady demand, is a factor in the average diamond price rising by 4.5 per cent in the first six months of the year.

It was that price rise which prompted our July 13 story that the outlook for diamonds as an investment looked the brightest for several years.

That thesis probably remains intact, for now. But it would be wise for any investor thinking about a portfolio exposure to diamonds to brush up on the latest developments, especially the FTC guidance on what constitutes a diamond, for advertising purposes, and the dramatic entry of De Beers into the world of lab-grown diamonds.

Special diamonds, such as the 5.03 carat Argyle pink auctioned by Bonhams in London earlier this week for a record $US583,551 per carat, for a total price of $US2.94 million, will continue to command ultra-high prices.

Technology turns the commodity tide

But, in the broader diamond market, there is a process of “commoditisation” underway. The gap created by a declining supply of mined diamonds is being plugged by an increasing supply of lab-grown gems.

Over time, lab-grown diamonds are likely to dominate the market because not only are big mines closing but mining companies are losing interest in exploration for diamonds.

Bain & Co, a consulting firm, recently calculated that exploration spending on diamonds as a percentage of revenue fell from 8 per cent in 2007 to 2 per cent today, despite demand for diamonds growing at between 1 per cent-and-4 per cent a year.

Fewer mined diamonds (and that FTC ruling) will have an effect on consumers who once rejected the concept of a man-made, or synthetic diamond, as something unattractive and basically “not the real thing”.

But over time lab-grown diamonds will develop a foothold as consumers discover that they (or anyone they’re trying to impress) cannot tell the difference between the two categories of diamond, because there isn’t any.

De Beers, guardian of the diamond industry for more than 100 years, has dropped all its once vitriolic objections to lab-grown diamonds and joined the game in a big way, a shift which might be described as the gamekeeper turned poacher.

Whichever way the new De Beers business of Lightbox is viewed, the undeniable facts are that the product itself is superb, the price is attractive, demand is strong, and the pipeline of shifting diamonds from the factory to the retail outlet is infinite.

That final point is what investors should pay closest attention to, because the days of diamonds being an item of scarcity are passing. While big players in the game will try to maintain prices at a high level, there are few, if any, barriers to entry for future diamond producers, so long as they’re prepared to compete with De Beers.