Outside In

Diamonds may be forever, but they are not an investor’s best friend

Some insist the industry downturn is cyclical and it will rebound by the end of the decade, but there is evidence the slide may be structural and long term

PUBLISHED : Friday, 21 October, 2016, 3:01pm
UPDATED : Saturday, 22 October, 2016, 3:33am

Impetuous, romantic and old fashioned as it may seem, I got married last month. So diamonds have been much on my mind, and of course have knocked a large hole in my bank balance. No comfort, then, to discover how poor an investment diamonds are. I’m sure the quality of the marriage more than makes up for it.

It seems the world’s diamond business – very important to Hong Kong, as one of the world’s leading diamond trading centres after Antwerp and Tel Aviv and host to at least nine diamond and jewellery fairs every year – is in a bit of a tizz. The value of worldwide sales last year fell by 2 per cent to US$79 billion – but the volume of sales of rough diamonds tumbled by around 30 per cent. In Hong Kong, jewellery-shop leader Chow Tai Fook has seen sales fall by 12 per cent this year, while Tse Sui Luen has reported an 8.6 per cent fall.

People in the business are bravely insisting that this is just a cyclical thing, and that we can expect a rebound by the end of the decade, but there is evidence that the slippage may be structural and long term.

On the cyclical side, people talk of lots of new diamond mines coming on stream. Most awesome is the Gahcho Kue mine recently opened in Canada’s steel-shatteringly cold Northern Territories which, coupled with Lukoil’s Grib mine in Russia, will be adding around 10 million carats of new diamonds a year by 2019. Add in the other new mines and the global output is expected to jump by 15 per cent to 150 million carats a year.

The cyclical argument also focuses on the 2008 global recession, its impact on diamond demand in the hard-hit rich markets of the west, and the fierce anti-corruption campaign in China that has dulled all sorts of luxury spending over the past three years. The slowdown in Chinese enthusiasm for life’s little luxuries has been a particular blow, not least here in Hong Kong where two thirds of the 140,000 buyers at this year’s two main shows were either from Hong Kong or the mainland.

In principle, mainland Chinese demand has a long way to grow. Only 30 per cent of Shanghai women claim to own a diamond, whereas in Hong Kong over 80 per cent own a diamond or three. Annual growth in demand for diamond and gold jewellery from the mainland was growing 7 per cent a year for most of the past decade, but has now slipped to barely more than 4 per cent.

This will arguably improve as China’s middle classes grow (almost 300 million households are expected to earn over US$15,000 a year by 2030, by comparison with 153 million last year) but big bets had been put on faster growth, with a result that the supply of diamonds has swollen much faster than demand.

The industry’s darker moments are focused on the structural changes that are challenging a highly profitable luxury market which, underpinned by De Beer’s six decade “A Diamond is Forever” mantra, has delivered strong profit growth over most of my lifetime. At least six structural factors cloud the future. First is a changing fashion among the millennial youngsters of the US, Europe and Japan that are now moving into marriageable and gift-giving age. Still today, in the US, engagement and wedding rings dominate the retail market for diamonds (10 million marriages in the past five years), so a decline in formal marriages – and the frequency of divorces – is having a big impact. Second, there are many other little luxuries competing against diamonds for attention among increasingly individualistic buyers – from the newest smartphone to a Caribbean breakaway.

Third, bad press over “blood diamonds” that have leaked into the market to finance civil wars in countries like Angola, the Ivory Coast or Sierra Leone has raised concerns about the ethics of buying diamonds. Nor does it help that almost one third of the world’s diamonds come from Russia. The Kimberley Mark certification process has helped – it is estimated that just 1 per cent of the world’s production today is being sold for illegal or unethical purposes compared with an estimated 20 per cent in the 1980s – but the taint sticks.

Fourth is the emergence of high quality synthetic diamonds, which today can be produced in weeks without the ethically awkward back-breaking labour of poorly-paid mine workers, are indistinguishable from “natural” diamonds, and cost a fraction of the “real” thing. Today, synthetics account for less than 1 per cent of the market, but how long will it stay that way? I sentimentally pray that the ring on my loved-one’s finger is the real thing, but in truth neither she nor any of her admiring girlfriends would be able to tell if it is not.

Mystery diamond buyer revealed: Hong Kong billionaire Joseph Lau spends US$48m on ‘Blue Moon Diamond’ for seven-year-old daughter

Fifth, the smart marketing of diamonds has floundered since the “good old days” in the 1980s when De Beers accounted for 90 per cent of the world market. In those days, De Beers spent US$200 million a year on marketing, and the rest of the industry rode on its marketing coattails. Today it accounts for just 31 per cent of world diamond sales, and has become increasingly reluctant to underwrite the industry’s marketing bill. As its own marketing budget has shrunk to US$120 million a year, it last year succeeded in establishing the Diamond Producers’ Association with six other mining giants, which has agreed jointly to fund marketing. Perhaps the new “Real is Rare” slogan will capture the luxury buyers’ imagination, but let’s see.

The sixth and final long term challenge is the simple reality that diamonds offer a very poor investment return compared to gold, or rare wines, or trendy paintings. The resale market for diamonds is tiny and illiquid – between 3-5 per cent of sales in any one year – and even the experts complain that the “4Cs” benchmark for valuing diamonds – colour, cut, clarity and carats – is subjective and intransparent. Clearly that didn’t bother Chinese Estates’ Joseph Lau who in the past year has bought a 12 carat fancy vivid blue diamond for US$48 million, and a 16 carat vivid pink diamond for US$28.5 million (calling it Sweet Josephine after his daughter). Of course, when I was choosing my loved-one’s wedding ring, investment value was the last thing on my mind – but then, perhaps I was putting less of my life savings at risk.

David Dodwell researches and writes about global, regional and Hong Kong challenges from a Hong Kong point of view