Will diamonds regain their lustre?

As expected, Anglo American released a gloomy set of full-year numbers this morning. What do figures from its De Beers unit says about the prospect for the UK’s mid-cap diamond miners?

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  1. Garry White

Anglo American is slashing its assets from 55 to 16. It plans to focus on three consumer orientated commodities, namely platinum group metals, which are used in catalytic converters in vehicles, copper, which has a wide range of uses, and diamonds.

Anglo will retain its 85% stake in De Beers. Today’s figures show price weakness over 2015, as demand waned. Operating profit at the operation slumped by 58% to $571m during the year. This was the result of weaker rough diamond demand and lower revenue, offset in part by tight cost control and favourable exchange rates. Diamonds are priced in dollars and the South African currency has been particularly weak, proving something of a cushion. Indeed, because of these two factors the costs of producing each carat mined fell from $111 to $104, despite lower volumes.

As a result, De Beers reduced production by about 12% - but it is interesting to note that the number of carats sold actually fell by 39%. This cut in production represented one of the biggest supply-side responses in the commodity industry.

Diamond prices recovered sharply after the great financial crisis, but they have been in decline since 2011. Demand was hit by a slowdown in luxury spending in Hong Kong and Macau, sparked by the Chinese government's crackdown on corruption.

This in itself is interesting. During the last downturn, industry advocates argued that China would eventually overtake the US as the biggest diamond market in the world. The US consumer was broke at that time and it was claimed that the slack would eventually be taken up by an expanding global middle class, often enthusiastic to adopt the Western tradition of diamond engagement rings.

However, this has not happened. Indeed, De Beer’s today noted that the US still represented 45% of the global market for polished diamonds. Management expects the US market to remain the main driver of growth in consumer demand in 2016. The extent of global growth will be dependent upon a number of macro-economic factors, including the strength of the dollar in addition to economic performance in China and its impact worldwide. Longer term, the sector is likely benefit from a continuing rise in the world's middle classes in emerging markets, particularly in China and India.

The fundamentals of the diamond market have long been seen as strong, because of a lack of new discoveries. Africa is the source of around 60% of the world’s diamonds by value and the two major FTSE 250 producers are based in the continent. How are they faring in the current situation?

Petra Diamonds has six operations in production – five in South Africa and one in Tanzania, including the world-famous Cullinan mine which produced stones used in the British Crown Jewels. Petra’s expansion plans mean it is spending heavily to extend the life of Cullinan at a time when sales are dwindling. As a result the shares have plunged from above 200p 18 months ago at around 86p now.

Management is targeting production of 5m carats a year by 2019, compared with output of 3.2m carats in 2014. However, because of its investment the group was forced to secure a covenant holiday from its bankers after fears it would its breach terms and conditions levels during the year.

Gem Diamonds owns the Letšeng mine in Lesotho and is developing the Ghaghoo mine in Botswana. The Letšeng mine is famous for the production of large, white diamonds, making it the highest average dollar per carat kimberlite diamond mine in the world. Since Gem Diamonds’ acquisition of Letšeng in 2006, the mine has produced four of the twenty largest white gem quality diamonds ever recorded. Gem differs from Petra because the company also cuts, polishes and markets a small percentage of its own stones. This adds more value to the stone when they are eventually sold, but is really a process that allows it to understand pricing of stones in the marketplace. Its shares have not really recovered from the financial crisis and are down by 12% in the year to date.

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