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Henry Bonner

Jason Stevens: Why I Believe Diamonds Are a Good 5-Year Play

Diamonds are penetrating Chinese and Indian jewelry markets, but reports on mine supply say diamond production may peak in the next two years and begin to decline. The graph below from McKinsey & Company shows expected future production1:

Mickinsey Diamond Production

Goldman Sachs reports that if current growth continues unabated, demand for diamonds should rise at a compound annual rate of 11% through 2017, mostly thanks to China and India.2

 Jewelry Demand Chart

Source: Bloomberg

Jason Stevens, an Investment Executive at Sprott Global Resource Investments Ltd., is reviewing specific opportunities in diamonds for some clients.

Jason recently commented on the situation in the diamond market:

Every scenario I’ve studied has demand outpacing supply for the foreseeable future.

Lack of new discoveries, diamond engagement rings becoming more common in developing countries, and strong household incomes among the American affluent all strengthen the case for diamond investments.

The industry expects production to start declining between 2018 and 2020. Mining companies are scrambling to find more diamond deposits.   Since 2000, they have spent $7 billion looking for diamonds, but the payoff has been meager. Rio Tinto made the only sizeable discovery in that timeframe, finding nearly 35 million carats at the Bunder Project in central India.  The Bunder Mine may produce an average of 2 million carats per year starting in 2017, or about 1.5% of annual global production2 -- far less than the amount they expect to come off the market between now and 2026.

The annual exploration budget of the diamond industry has essentially been cut in half since’07 and ’08. According to data compiled by SNL Metals & Mining Research, the global diamond exploration fell from $985 million in 2007 to $489 million in 2013. The percentage of global exploration dollars allocated to diamonds also fell from 9% of total exploration budgets in 2007 to only 3.4% in 2013.3 The below chart from SNL Metals & Mining reproduced by DeBeers shows how money for diamond exploration has dropped off:

Diamond Exploration Budgets Mckinsey

Many mining companies are searching historically under-explored areas of the Congo and other parts of Africa, although diamonds from some of these regions are generally considered to have lower quality.

In the unlikely event of a big new discovery, it would still be unlikely to affect global supply in a relevant timeframe.

From 1950, new diamond discoveries have taken14 years on average to reach production4. Technical difficulties, financing problems, and local politics all contribute to development delays of diamond discoveries.

Maintaining existing production will be a major challenge for the industry as some of the largest diamond mines are entering their sunset years. Australia’s Argyle Mine, for example, has been producing since 1981. It produced approximately 12.6 million carats in 2014, or 9% of global supply (second in production to DeBeer’s Orapa Mine in Botswana). Argyle is expected to shut down in 2020.5

Like precious metals deposits, diamond-producing ‘pipes’ often occur as clusters. The best place to look for new mines is around existing mines. The lack of new discoveries in these areas has led some miners to expand to more costly underground operations. For instance, DeBeers and the government of Botswana have committed to spending $3 billion to extend the life of the Jwaneng Mine to 2025.6

Over 80% of annual production comes from just 20 mines. Any disruptions at these mines can have large consequences to industry players down the value chain. In anticipation of future supply complications, major jewelry retailers have begun integrating backwards by investing in mines to help secure their supply.

What about demand? Will it continue to be strong? 

Unlike other resource sectors, diamond demand is almost entirely set by consumer demand for diamond jewelry.  While penetration of developing markets in Asia is expected to ensure demand growth, I believe that, in the short term, the industry will live and die by demand originating in the US.

Average incomes for the top one percent of Americans have grown much faster in the last couple years than national average wages.  According to Equity Communications, in 2013, female consumers with household income of over US$150,000 accounted for the acquisition of 14% of diamond jewelry pieces and 33% of sales by value.7  Recent strength in stocks and real-estate, which rich households tend to own in large amounts, has emboldened this demographic. They also tend to be the most loyal repeat buyers.

Today, I’m attracted to advanced-stage projects with near-term production and high operating margins.

These projects should provide healthy cash flows in the current pricing environment. They may also catch the upside from a potential tightening of supply.

According to Bain & Company’s The Global Diamond Report 2013, rough diamond mining has the largest profit margin on the value chain. In the diamond business, cutting/polishing, jewelry manufacturing, and retail sales all make lower profit margins than mining.

Part of the reason is an upside that is unique to diamond mining. Analysis and mine planners tend to under-estimate the amount of rare or exceptional stones that might be uncovered. Yet these exceptional discoveries can be windfalls for miners that add to their existing revenues.

In the case of Lucara Diamonds, the company sold 50 exceptional stones in 2014 for a total of $136 million, including 8 stones that sold for over $5 million each.8

Jason Stevens cautions that potential investors should examine projects for logistical issues – for instance challenges from operating in remote areas, where much of new exploration is currently focused. Although Jason sees this as a 5-10-year strategy, you can contact him today at 800 477 7853 or jstevens@sprottglobal.com to discuss what companies he’s following now.

P.S.: To receive monthly top news stories in the resource sector from Jason, click here.

1 De Beers: The Diamond Insight Report 2014 (p.15)
2 http://www.business-standard.com/article/companies/rio-tinto-strikes-diamonds-in-bundelkhand-s-bunder-114010800057_1.html
3 SNL Metals & Mining Research: Corporate Exploration Strategies 2013.
4 De Beers: The Diamond Insight Report 2014 (p.45)
5 http://www.miningglobal.com/top10/1175/Top-10:-Diamond-Mines-in-the-World
6 http://www.bloomberg.com/news/2010-12-10/debswana-extension-of-jwaneng-diamond-mine-to-create-1-700-jobs.html
7 http://www.diamondshades.com/files/8214/1303/4244/8_Key_Questions_on_Future_of_Diamond_Industry_2.pdf
8 http://www.marketwired.com/press-release/lucaras-exceptional-stone-tenders-bring-in-136-million-in-2014-tsx-luc-1959833.htm

 

This information is for information purposes only and is not intended to be an offer or solicitation for the sale of any financial product or service or a recommendation or determination by Sprott Global Resource Investments Ltd. that any investment strategy is suitable for a specific investor. Investors should seek financial advice regarding the suitability of any investment strategy based on the objectives of the investor, financial situation, investment horizon, and their particular needs. This information is not intended to provide financial, tax, legal, accounting or other professional advice since such advice always requires consideration of individual circumstances. The products discussed herein are not insured by the FDIC or any other governmental agency, are subject to risks, including a possible loss of the principal amount invested.

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