Investing in the Diamond Trade in 2010

Financial crises are never fair. The good get hurt along with the bad. The strong are punished with the weak.

In tough times banks are desperate to restore their balance sheets. They know they can only recover money from those that have it. There is no point in pursuing the basket cases.

I’ve lost count of how many business executives I’ve spoken to in the last twelve months who have told me of fearful rows with bankers. Finance that was there one day was withdrawn the next.

Just two weeks ago I met a man who had spent fifteen years building a business only to see it threatened with break-up when his banker suddenly asked for $3m. Only after fighting tooth and nail – ‘it got personal’, he told me – did he manage to save the day.

But now the crisis is easing. Credit is starting to oil the wheels of commerce again, and one group of craftsmen are especially thankful. These are the world’s diamantaires.

Why diamond shares crashed in 2008

Diamonds, as everybody knows, are expensive items. They are high value when they come out of the mine. When they’ve been separated from the ore and recovered in rough form, they fetch an even higher price. Polish them and cut them, ready to be set into rings and they can command a massive price tag.

This is a process that takes time. Central to it are the folk known as diamantaires. These are the people who take the rough diamonds and turn them into jewellery. It is a special skill, passed down from father to son. Several generations of the same family have peered and squinted through eyeglasses, cut and polished the gems and muttered ‘very nice, very nice’.

It is lonely, satisfying work. But it depends upon finance. The diamantaire must pay for the rough diamonds long before he can sell the finished jewel. It is a textbook example of an activity that requires working capital. The banks must lend the diamantaire the money to buy the rough diamonds. They must then wait to be repaid.

But in the last two years this was not happening. The mechanism broke down. The banks refused to offer credit. Diamantaires were unable to buy rough diamonds. And so the price of rough diamonds collapsed.

Unfairly the diamond trade was a victim of a financial crisis born by reckless property speculators and greedy bankers. It was caught in the cross-fire, an unwilling and undeserving victim. But it suffered nonetheless.

The price of rough diamonds tumbled and the trade seized up. Now, though, the recovery is underway. This much was confirmed last week by Petra Diamonds (ticker: PDL), one of the world’s leading suppliers of rough diamonds.

It said that the rough diamond market has staged a significant recovery. ‘The emerging consumer markets of India and China’, it went on, ‘continued to expand and helped to take up the slack caused by the weaker US and European markets.’

Furthermore ‘analysts recently reported a rise in pre-Christmas sales of jewellery in the U.S., still the largest and most influential jewellery market in the world... boding well for the rough diamond market for 2010.’

Now banks are lending again, this sector is hot

But this is not all, because the banks are playing ball again. Listen, again, to Petra:

‘Confidence has returned to the rough diamond market, with financing now beginning to open again… the second half of 2009 saw the return of many of the more cautious participants to the market and Petra noted a strong increase in attendance at our tenders. Certainly levels of competition for rough diamonds are now much closer to normal levels and serve to underpin the stability of the market.’

In other words the diamond business is rapidly staging a comeback, and investors should take note.

Remember this. While demand for diamonds rises inexorably there are very few places in the world that have the geological characteristics that could conceivably host diamonds. Most of these have already been exploited.

In the long term demand is set to exceed supply. And in the short term, confidence is returning to the market. Share prices of diamond producers are rising fast. In the last month African Diamonds (ticker: AFD) is up 43%, and Namakwa Diamonds (ticker: NAD) is up 33%.

In the January issue of Red Hot Penny Shares I prepared a special briefing on the obscure, but highly profitable world of diamonds. And I revealed my top pick for the sector. Find out how to get your copy here.

Best wishes,

Tom Bulford
For The Right Side

Editor’s note: Tom Bulford is the editor of the UK’s leading small cap investment newsletter, Red Hot Penny Shares. It’s a monthly newsletter dedicated to uncovering the most exciting penny shares for potentially explosive profits. I urge you to give it a try. To see what other investors are saying about Red Hot Penny Shares and to claim your 3-month without obligation trial subscription, just click here.

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Investing in the Diamond Trade in 2010

Battered by the Financial Crisis, Now this Sector is Roaring Back