During the holiday season we tend to reflect on events that have taken place thousands of years ago and rediscover their relevancy for present times. From a historical perspective, the diamond industry is still very young; its history is measured in decades or, at best, a few hundred years.

The Great Depression of the 1930’s was when the industry faced its greatest crisis – and, measured by the results, it may have been turned into the industry’s greatest triumph. It happened exactly 76 years ago: in 1932, when the world was enmeshed in the Great Depression, De Beers Chairman Ernest Oppenheimer made a unilateral decision to close all of the company’s diamond mines. No exception. Apparently, this decision was made without prior South African Union government approval. Based on the ensuing debate, such consent would not have been given – the government had a different agenda. 

In parallel to the present global financial meltdown, the current troubles in the diamond industry were not created but rather exacerbated by the banking crisis. Likewise in the Great Depression. When the stock market crashed a few years earlier, in 1929, the world was already facing a severe overproduction of rough diamonds. At the onset of the Great Depression, the bad situation deteriorated further. In 1929, world production of diamonds totaled 7.4 million carats (of which 57 percent was of industrial qualities, unfit for jewelry); by 1933, it had gone down to 4.0 million carats (of which 83 percent was industrial).

So is there really any relevance to today’s situation? Yes, far more than one would expect. Though De Beers was a major player during the Great Depression, the company wasn’t totally in control. Actually, it delivered only about 50 percent of the goods to the then-existing producers’ Syndicate. Today, De Beers holds about 45 percent of the world’s rough supplies.

Most of the South African output during the Great Depression came from (state-controlled) alluvial diggings, and the government was extremely reluctant to decrease production so as to secure continued employment in the diamond sector. When De Beers, as a company, did what it felt was in its own best interest and closed its mines, other mines followed suit and either shut down or severely curtailed production – including in Angola and the Congo. By the end of 1932, De Beers Chairman Ernest Oppenheimer was able to inform his shareholders that “with the exceptions of the South African state diggings, all productions of diamonds in the Union of South Africa and in South West Africa has ceased for the time being. The producers outside the Union have co-operated with producers in the Union in bringing about material reductions in production and prospecting work and in reducing or ceasing deliveries of diamonds [to the markets].”

The near stoppage of supply prevented a further slide in the value of the inventories of the trade in the cutting centers – and those of De Beers itself. The market started to improve. It worked. And, most significantly, the supply stoppage brought about an immediate reversal of the slide in rough prices.

The U.K. Wholesale Price Index for rough diamonds had collapsed from 100 in 1929 to 58 in 1932. This was a decline of 42 percent within three years. However, in 1933, when the worldwide supply had almost halved because of the 1932 cutbacks, the Price Index rose steeply to 95 – almost back to the pre-crash 1929 levels. Production growth followed. By 1937, worldwide production reached 9.6 million carats – and the price index (in that year alone) topped 102, slightly above the 1929 levels.

Though in these years there were various production quotas and delivery agreements within the De Beers-dominated Diamond Corporation, there was not yet a single authority with control over both production and selling. This was only achieved in 1934, when the establishment of the Diamond Trading Company (that later became the Central Selling Organisation) was agreed among the producers and with blessing of South Africa’s government. We’ll probably never know whether the DTC would have been created if there would not have been a Great Depression at the time.

In the current global financial crisis, the situation is similar to that of 1932 in that there is no single authority that can force diamond mines to close down or reduce output. But most diamond mining operations are taking actions either to close down temporarily or to reduce output. The Russians will mostly stockpile (by selling rough to its government). South Africa and South West Africa (now Namibia) took the greatest hit in the Great Depression; that unpleasant role will now be assumed by Botswana.

This week’s newspapers report on job redundancies of over 1,000 workers in Botswana’s Damtshaa, Orapa No. 2 and Letlhakane mines, which are already partly closed. And not just for the holidays. Only Botswana’s most profitable productions (Jwaneng and Orapa No. 1) will remain unaffected. De Beers has publicly stated that its mining operations will face cutbacks “in line with prevailing market conditions.” What will that mean?

2009 Expected Rough Demand 50% Lower than in 2008

Our revised research updates – which we’ll publish early next year – clearly indicate that the demand for rough diamonds from the cutting centers in 2009 will be some 50 percent below the 2008 levels. If rough prices decline further, in value terms the reduction may even be steeper. If De Beers sold about $6 billion-plus in 2008, it will not be able to sell much above $3 billion in 2009, assuming the company will maintain its relative market share. However, if supplies to the market are curtailed by the full aforementioned 50 percent, rough prices may remain stable or even strengthen.

This is in the hands of the producers. It is in their own best self-interest. The arithmetic is rather straightforward. If, for example, the Argyle-type rough will not pick up, it stands to reason that this major mine will be closed forever within a matter of months.

The world diamond output in 2008, measured in carats, is 40 times (!!) higher than in 1933. The pipeline is far heavier. In the 1930’s the stocks were held – and financed – mostly by the producers; today they are held by the downstream players – primarily the cutting and trading centers and the retail trade. Producer stocks are minimal.

Though it is hard to give exact estimates, we believe that the rough and polished inventories in the diamond pipeline (from cutting centers to consumers), measured in polished wholesale prices, total some $45-$50 billion. The cutting and trading center debts (excluding the jewelry wholesale and retail) are in the range of $15-$18 billion, which is less than one year of worldwide polished consumption. Though these figures may sound staggering, they are actually quite reasonable. The financial crisis has forced a glass ceiling on these figures – a ceiling which might temporarily be broken by government intervention in the cutting centers. I wouldn’t count on it.

At the end of the day, the price developments will depend on the supply side. Producers are reducing mining activities mostly to improve their cash-flow management. They don’t want stocks and don’t want to finance stocks.

This was different in the Great Depression. By the end of 1935, for example, the stocks held by the Diamond Corporation (on behalf of the producers) were £12,449,000, compared to worldwide sales of the Diamond Trading Company of merely £3,260,000. This was, however, a peak year in terms of producers’ stocks. In 1937, producer stocks and annual sales were in balance (respectively, £9,857,000 and £9,164,000).

Industry Driven by Supply Shortages

If these figures show anything, it is that the recovery after the Great Depression, when it came, came quite quickly. That may be different this time since analysts predict that consumer behavior will change – and the change may be lasting. We don’t know yet how high diamond jewelry will remain as a spending priority. Customer visits to U.S. retailers fell 24 percent last weekend compared with a year earlier, the biggest drop on record. Even the deepened discounts failed to attract consumers.

Part of this bad showing may be attributed to inclement weather and a slowing U.S. economy. It is self-evident that consumers were working with smaller budgets for holiday gifts this year because of rising unemployment and declining home values. There is no evidence as of yet that there is a change in overall consumer behavior.

McKinsey researchers stress that past recessions have affected spending on different categories of consumer goods in different ways. They didn’t go back to the 1930’s but rather to recent downturns. An analysis of consumer spending during the 1990–91 and 2001–02 downturns shows that US consumers changed their priorities instead of making across-the-board cuts. Daily amenities – eating out, personal-care products and services, and apparel – tended to suffer. But categories such as groceries and reading materials, which substituted for more expensive options, actually benefited from higher spending, as did less discretionary items, like insurance and health care. Spending on education showed the biggest increase, says McKinsey.

The firm also cautions that while these historical trends are instructive, they may not tell the whole story this time around: tighter consumer credit, low personal-savings rates and declining home values may cause individuals to cut spending faster and further across more categories. This doesn’t point to a lasting change. Nevertheless, we must be careful.

It is obvious that a Japan-type almost permanent non-recovery in diamond consumption after the Asian meltdown (and the bursting of the Japanese assets bubble) of the 1990’s must be avoided in the U.S. at any price. De Beers is counting on the assumption that tomorrow’s consumer will look for lasting-value products. Diamonds will be marketed stressing the foreverness of its value.

Ironically, this reinforces the notion that price stability remains the cornerstone of the industry’s survival strategy. A price collapse will never make for a convincing consumer promotion on lasting values, nor will it encourage investments in diamonds. With the inventories and the pipeline debts in the hands of the downstream players – who will have to hang on by their teeth – producers will have to resort again to the proven strategies of the early 1930’s. And, as a matter of fact, I believe they will.

The global financial crisis has not changed the supply fundamentals in the diamond industry. After we are back to “normal” (a process I expect will start in earnest in the fourth quarter of 2010), rough supply shortages – caused by declining production and failure to discover new major mines – will continue to drive rough prices.

The total “size” of the industry, however, seems to be heading to a near-permanent contraction. The current crisis will expedite a process of consolidation and “shake-down” that would have been inevitable in any event. The challenge facing each and every player in 2009 is to survive the crisis and come out stronger – while knowing that many marginal players will need to depart from the industry.

So while there is much pain ahead – there is also hope and expectations. During the Great Depression, the industry came together and restructured – and found much government understanding in the process. There are valuable lessons to be learned from the past.

A Happy New Year to you all.