The coming supply crunch in diamonds

Last week, Alrosa, the world’s second largest diamond miner, plucked out a stone weighing 158.2 carats from its Nyurbinsk mine in Russia’s north-eastern republic of Sakha (Yakutia). That is a quite remarkable size; at auction that is worth about $1.5m, and by the time it has been cut and polished it will be worth a great deal more.

In fact, Alrosa produces 97% of all diamonds in Russia and accounts for about 28% of global production. It is a name you could soon be hearing a lot more of as it is rumoured to be preparing a stock market flotation.

That would cast the spotlight on the diamond mining industry. There is an air of optimism about the future of this sought after precious stone, as I discovered last week when I met Robert Bouquet, a director of diamond mining junior Botswana Diamonds (AIM: BOD).

Only 1% of sites turn out commercially viable diamonds

Botswana Diamonds has projects in Botswana, Cameroon and, potentially, Zimbabwe, a political hotbed but a country that hosts the extraordinarily rich Marange diamond mine. Bouquet was excited about the potential for the company, especially in Cameroon. But it was his insight into the industry that interested me.

The price of rough diamonds has shot up in recent years and quickly recovered from the financing crisis of 2009. Although, there was some easing of the diamond price this summer, sentiment is still bullish, and it is not hard to see why.

Diamonds are exceptionally difficult to find. Although there are some alluvial sources, washed downstream by ancient rivers, 95% of diamonds have erupted from deep in the earth’s crust and are found in vertical pipes known as kimberlites or, occasionally, lamproites. The location of these kimberlites is known, but they do not necessarily yield diamond mines. Only about 1% of kimberlites discovered to date have proved to be commercially viable, so with this low success rate and a finite number of kimberlites left to explore, there is no chance of a sudden increase in supply.

A supply crunch is on the way

Global production of diamonds amounted to 124 million carats in 2011, and according to a report by Bain, 13 new mines will add 23 million carats by 2012. Balancing this against the depletion of existing mines, aggregate diamond production is forecast to increase by 2.8% a year to 2020. But that figure is not sufficient to match forecast demand.

Although the USA remains the largest market for diamonds, the rapid growth of the Chinese and Indian middle classes is expected to have the biggest impact on the equation. In these two countries the number of households with a disposable income of $15,000 is expected to rise to about 469 million in 2020 from about 220 million today.

That seems certain to boost demand for diamonds, and since consumers have a tendency to equate price with worth, rising prices could lead them to value diamonds even more highly than they do today.

The trouble with diamonds

And yet the diamond market is a strange one. Thanks to the efforts of De Beers, which cornered the market at the beginning of the 20th century, and came up with ‘diamonds are a girl’s best friend’, brides and grooms all over the world are now convinced that their devotion should be measured by this particular precious stone. De Beers has now lost its stranglehold on the industry, and without a sustained and consistent marketing campaign, future brides and grooms could decide that emeralds, for instance, are no lesser tokens of love.

Also having an effect on the supply of diamonds is the Kimberley Process which, in theory anyway, prevents the sale of ‘conflict diamonds’ from financing brutal regimes. The other shadow hanging over the industry is synthetic diamonds. It is possible to make diamonds in a laboratory and, given that these can only be identified by experts using advanced inspection tools, you can be certain that they would hoodwink the average consumer.

While the trade has managed to convince itself that consumers would not be satisfied with artificial diamonds, industrial users have no such qualms, and 95% of industrial diamonds are synthetic.

Finally, the attraction of diamonds is that, like gold, they last for ever. That means that every diamond that has ever been produced is still in existence. To the extent to which owners choose to pluck their grandmother’s diamond jewellery from the bottom drawer and flog it, supply will be affected.

The bullish case for diamonds is not all it might seem. But even with these reservations, the industry looks well placed. The penny share diamond miner that I have chosen for Red Hot Penny Shares has just taken an important step forward, and brokers are arguing that it is worth more than three times its price today!

• This article is taken from Tom Bulford’s free twice-weekly small-cap investment email The Penny Sleuth. Sign up to The Penny Sleuth here.

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  • ken

    Hi,
    Tom misses the point about using a fund. I invested £25k spread over 4 funds with Hargreaves Lansdown for my grandson when he was 15. He is now 19 but the value is the same because of the present crisis. What else could I do. I won’t be around for ever and it is a long term investment for say a pension when he is 60. I do not have time to study the market daily and move in and out.

  • Ian T S.

    You made no mention of Argyll Diamonds WA, Australia. Are they still a major producer of quality stones and is genuine Argyll Pink still the most valuable of all the coloured stones. If so where does that place the value of the Australian resource?

  • Michael Van Moppes

    I come from one of the world’s leading diamond families, with the great fortune of being in one of the poorer branches, so I have avoided the miserable life that many mega rich have. We were in industrials, and quoted on the London Stock Exchange as an engineering business. I left the firm in 1968, and life has been fun.

    I am happy to help with diamond investments. I do not have much confidence in the industry today and have none in my portfolios. I am a strong supporter of De Beers, a firm that could be completely trusted when I knew it, and I am sure still applies today. It was the only beneficial monopoly in the world, one that everyone involved benefited from. That included the miners and customers as well as the trade.

  • Michael Van Moppes

    Ian T S,

    That is not correct. Yes, Argyll is the World’s main producer of pink stones and yes, they are very valuable, but incredibly rare in Argyll’s lamprolite; we are talking of parts per billion, or per trillion. The vastest proportion of Argyle’s production is brown stones, the least desirable colour for a gemstone, and the cheapest. So, not quality stones; the opposite.

    My advice is, do not listen to the marketing hype when you are considering investing.

    Mike

  • Bill

    ‘Trillions of carats’ of diamonds found under Russian asteroid crater’
    By Ian Steadman18 September 12

    http://www.wired.co.uk/news/archive/2012-09/18/russian-diamond-smorgasbord

  • Nick Fury

    Diamonds are worth very little in reality…try buying one and then take it back and see how much they offer you 10-20% if you’re lucky. Diamond value is the true conspiracy. DeBeers can teach the financial maket a thing or two about artificially fixing prices and maket manipulation. Unless you’ve got a ‘Pink Panther’ or ‘Mountain of Light’ forget it, it’s all junk. what with synthetics; moissanite, zirco, paste you’ll rarely know what’s what anyway. Then add ‘all risks’ insurance and you’ll soon be paying a premium every year to own one. Go Gold, Go Gold, Go Gold, Gold!!!

  • Orb

    Hey Tom, is this another Firestone-style recommendation?

    :-)

  • Clive

    I agree with Nick Fury – until there’s a transparent market that quotes both buying AND selling prices for diamonds (determined perhaps by their certificates on carat, grade etc.), then the ‘value’ of diamonds is basically just smoke and mirrors based on the fact they’re sparkly.

  • Peter

    Totally agree with Clive & Nick Fury, diamonds are worst investment tool ever. Confusion over valuation, absence of spot market makes Diamond bad investment option. Regarding supply crunch, it has always been stated that leading Diamond Mining companies (most notably De-beers) limit the production to jack up the prices. It has been often noticed once a mine is freed from these companies production/forecast production increases.
    Other than that what is wrong with Synthetic Lab grown diamond, (I think “Artificial Diamonds” is a wrong description).
    Synthetic diamonds match all the properties which make natural diamonds unique, rather it improves these properties and as stated in the article rampant adoption of synthetic diamonds for industrial use ins the proof. Its high time we release the century long trickery of mankind by mining companies.

  • Colin Selig-Smith

    Not a fan of diamonds at all. They like most precious stones can be mass produced. There are Russians and Americans with facilities doing exactly that. Coming from a chemistry background a diamond is just a lump of carbon in a particular crystal lattice and the manufactured diamonds are completely genuine diamonds. We’ll see large high quality stones on ebay for pennies in the future as production increases and scarcity evaporates.

  • GFL

    Yes I agree, I’m surprised lab created diamonds have not got more coverage. Diamonds created in a lab, have the exact same properties as those coming coming out of the ground.

    Precious stones are terrible store of value, and will only get worse as lab production gets more sophisticated.

  • Ami

    The main barriers that deter investors from investing in polished diamonds;

    1. No public market for diamonds
    2. Complexity of assessing and pricing each stone
    3. Secure storage and insurance
    4. Difficulty of resale

    All these issues are successfully addressed by Waldman Diamond Investments.

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