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Diamonds lose some of their lustre

Posted: Thu, 04 Sep 2008

[miningmx.com] -- SHARES in junior diamond producers have taken a further pounding in recent weeks as investors have become more jittery about the impact of a prolonged recession in the US.

The country is by far the world’s largest market for retail diamond jewellery, accounting for about 50% of annual consumption.

While diamond mining company shares have been under pressure for most of the year, rough diamond prices have been firm. De Beers has pushed through a series of price increases, amounting in total to about 16%.

That is changing according to Des Kilalea, an analyst with RBC Capital Markets, and Ori Temkin, CEO of diamond group Steinmetz.

Addressing a presentation to investors in Johannesburg on Thursday by Rockwell Diamonds, Temkin said rough diamond prices had started coming off over the last six weeks and were about 10% down on average.

He commented that there had been a “sharp decline in speculative dealing in the larger, more valuable rough gems between diamond traders themselves”.

Rockwell diamond marketing manager Jeffrey Brenner said: “The last quarter has not been a great one for diamond sales. Diamonds are a luxury product and we are not recession-proof.”

The pull-back in rough diamond prices and the collapse of diamond mining company shares have taken place despite the fact that medium-term conditions for the business look good.

In a recent research report, Kilalea said: “While the near term for diamond prices appears uncertain, a shortage of gem-quality diamonds is expected to develop over the next three to five years as new production is not forecast to keep up with growing demand.

“The emergence of China and India as new markets for diamond jewellery will aggravate this shortage, and is expected to lead to higher prices for rough diamonds.”

But Kilalea reckoned the next 12 months would see weaker diamond prices because of the damage to consumer disposable income and confidence.

He said: “This could even impact prices of better quality diamonds which, most industry commentators say, are less vulnerable to economic hardship because of buying from consumers and investors in, among others, oil-producing nations.

“The last time prices of quality diamonds were knocked back was in 1980-1985, when inflationary expectations fuelled a price bubble which burst.”

According to Temkin, high-quality diamond prices are already affected with buyers in the US holding off from purchases, even though they could afford them.

Turning to the listed diamond companies, Kilalea reckoned share prices were discounting falls in diamond prices of between 20% and 30%.

One of the worst-affected companies has been Rockwell, which dropped 67% this year to a 12-month low of C$0.16 but has recovered slightly to around C$0.175.

The best performer has been Clifford Elphick’s Gem Diamonds, but even Gem has taken punishment since publication of its interim results last week.

These disappointed the market and some 10% has been knocked off the Gem share price since the results came out.

Kilalea said: “While difficult trading conditions still lie ahead, the fall in share prices is creating some deep value opportunities, primarily in companies which have growing production and no need to source capital in risk-averse markets.”

Kilalea’s two top picks are Gem and Petra Diamonds.

“While Gem avoided most of the carnage in the sector, Petra has been hit by sales from investment funds facing redemptions.

“This has driven Petra’s price to a two-year low, from where we believe it offers good value.

“Gem offers the prospect of increased production from three mines and a new mine in Botswana within five years,” he said.

But he stressed that catalysts for a general upward re-rating of diamond shares were “not obvious”, so the only factors which would drive share prices higher were company-specific news and further industry consolidation.

James Allan, partner in corporate mining finance firm Allan Hochreiter, said: “Diamond companies have to deliver and perform, otherwise the share prices come off because the market gets bored with the story.”

Rockwell’s production in the September quarter was badly affected by a five-week strike which has now been settled.

Kilalea’s assessment on Rockwell was that production loss would likely result in the company reporting a negative cashflow for its financial year.

He said: “The resolution of the strike should enable the company to move back towards budgeted production levels and positive cash flow.

“But the likely higher base from which costs will start in South Africa is of major concern, given that alluvial producers rely on keeping tight control on costs to maintain a healthy margin in low-grade deposits.”