All of a sudden, diamonds are wanting attention-grabbing once more. The cutbacks in diamond manufacturing final yr, allied to the substantial fall in manufacturing capability in India (the foremost diamond reducing centre) on account of the Pandemic, towards persevering with sturdy retail demand for diamond jewelry has cleared out the billions of {dollars} of tough and polished stock overhang within the mid-stream. No new apparent sources of provide while demand continues to be sturdy and for the primary time in additional than some time, tough and polished diamond costs are rising strongly.

So why aren’t a wave of early traders pouring into diamond shares? Why aren’t the bars round Bay Avenue abuzz with discuss of latest diamond investments? Solely 5 years in the past, the mixed market capitalisation of the bigger Canadian diamond miners — Dominion Diamond Mines, Mountain Province Diamonds and Stornoway Diamonds — was $2.eight billion. The reply is that whereas diamonds might have been “a woman’s finest good friend” for Marilyn Monroe, if you happen to have been an investor within the diamond mining area, it’s been something however enjoyable, in actual fact for a lot of it changed into a nightmare. What did traders miss? That is an extremely essential query to reply if they don’t seem to be to make the identical mistake once more.

The primary level is a macro one, which was past any investor’s management. From mid-2011 till the center of final yr we had been in a bear marketplace for diamond costs. However since August final yr polished diamond costs are up round 12%, and by many accounts are persevering with to rise. Diamonds are a sophisticated enterprise; the market lacks transparency, ore our bodies aren’t uniform and tough diamond pricing is opaque, so greater than nearly some other useful resource sector, the pricing framework wanted to be correct. It wasn’t.

How so? Nicely let’s take the gold business. The gold value on June 9 was round US$1,890 per ounce. What number of gold firms are you aware that may right now worth a brand new venture utilizing a long-term value of US$1,890 per ounce? None that I do know of. Most would use between US$1,300 and US$1,600 per ounce. The worth of copper on June 9 was round US$9,980 per tonne. Does that imply that many copper firms valuing a brand new venture right now would use US$9,980 per tonne for his or her long-term value forecast? I feel not. Most would use between US$6,000 and US$7,000 per tonne. They usually don’t escalate future costs in actual phrases, nonetheless a lot it makes a deposit extra engaging. Why? I doubt many traders would stand for it.

So what’s it about diamonds that nobody questions when a diamond mining firm makes use of the spot diamond value as the premise for valuing a brand new venture (particularly when so many firms have gotten that fallacious)? Why does nobody query a diamond mining firm when it escalates future actual diamond costs to justify a brand new venture? Diamond costs don’t all the time go up. The truth is, they usually go down. Escalate future base metallic or gold costs for a lot of presently uneconomic deposits by between 2-4% in actual phrases and I’ve little doubt you may make them financial. However at what threat? Diamond costs might go up or down by as a lot as 50% in an financial cycle, however over the long-term there isn’t any historic precedent for utilizing actual rising costs over the long-term, until you rigorously select your begin date to fit your story. And escalating diamond pricing by 2.5% per yr is already constructing into the valuation a 28% rise in diamond costs over 10 years — so on a threat reward foundation, that’s numerous upside already priced in.

Working example: Again in 2011 Stornoway Diamonds forecast a mean diamond value of US$182 per carat with a internet current worth for the Renard diamond mine of $391 million. In 2014 that value forecast had risen to US$190. In July of that yr Orion Mine Finance and Caisse de Depot offered US$250 million of financing in return for a stream of 20% of the diamonds at US$56 per carat. That’s, they’d pay US$56 for every carat that they may promote for US$190. By 2016, the forecast internet current worth had risen to $974 million with future actual diamond costs being escalated by 2.5% a yr.  On the first sale in November 2016, Stornoway introduced that they had achieved a value of US$195 per carat, however added that they didn’t promote a portion of cheaper items. Issues couldn’t have appeared higher. For fiscal yr 2017, they achieved US$85 per carat. Why? They recovered fewer giant diamonds than they anticipated and had an surprising degree of breakage in these they did recuperate. However that’s not the purpose.  They used what they believed to be the spot diamond value, after which escalated it. In simplistic phrases, based mostly on their then mineral reserve of 17.9 million carats, that could be a distinction (utilizing un-escalated future diamond pricing) of US$1.eight billion in income. Sport changer. From a excessive of round $1.60 a share in 2011, by the top of 2019 (pre-Pandemic) the shares have been buying and selling at spherical 2¢.

One other living proof: In 2013, Dominion Diamond bought a controlling stake within the Ekati diamond mine for US$553 million. The gravy within the deal was the (Four carats per tonne) Distress Foremost pipe. On the time of the acquisition and based mostly on BHP’s value e-book, Distress’s diamonds have been value US$112 per carat, which means the ore physique was value a staggering US$448 per tonne. Based mostly on Dominion Diamond’s February 2016 value e-book, these diamonds have been repriced as US$75 per carat, a yr later they have been right down to US$63 per carat (on a like for like foundation). Utilizing again of the envelope numbers, that’s US$588 million of anticipated income (and that’s with out escalating future diamond costs) that’s gone up in smoke. Why? The marketplace for these kind of diamonds weakened. Possibly that was unforeseeable, however what may be very tough to justify is why each the corporate and plenty of analysts have been nonetheless escalating future diamond costs by 2.5% a yr. In the event you ran the monetary mannequin offered within the March 2015 Ekati 43-101, utilizing a 2.5% actual diamond value escalation fee, Ekati had a worth of $1.5 billion. Nice buy! However if you happen to don’t escalate diamond costs then the quantity falls to $890 million. Strive getting the numbers for the Jay Pipe to work with out escalating diamond costs. They don’t. Dominion shareholders bought partially rescued in 2017 by a bid from a non-public firm within the U.S. with no earlier experience in diamonds. Dominion went into administration early final yr and the bondholders who offered financing misplaced nearly every little thing.    

I might go on about diamond pricing and escalating future diamond costs, and the impression on different (not simply Canadian) diamond mining firms, however hopefully the purpose is made. Don’t escalate future diamond costs and watch out about diamond valuations. If diamond costs proceed to rise (which they might properly do), you’ll be in an excellent place, and in the event that they don’t, being cautious makes it more likely you’ll preserve your cash.   

Relating to tough diamond pricing. Caveat very a lot Emptor.

Richard Chetwode runs a diamond consultancy enterprise. He’s additionally chairman of Namibian Diamond Mining Firm Trustco Sources, is chairman of the Advisory Board of Australian expertise firm Nice Arts Bourse, and is a advisor to a number of diamond (and different) companies. All of the opinions on this article are his personal.


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