Sea of Diamonds

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Sea of Diamonds to Outpace Metals as Scarcity, Asia Sales Boost Prices

Aug. 7, 2006 (found at Bloomberg) -- For the first time in 25 years, diamond production is declining and that may make the world's most coveted stones a better investment than copper, nickel and zinc, this year's top-performing commodities.

Output from diamond mines worldwide is likely to fall 2 percent by 2015, says James Picton, a diamond analyst at W.H. Ireland who's been following the industry for 35 years. Production has increased about 9 percent in the past five years, according to the New York-based World Diamond Council, as mining companies hurried to find new deposits to meet soaring demand.

A rally in prices will fuel earnings for producers African Diamonds Plc and Petra Diamond Ltd., according to Merrill Lynch & Co. and JPMorgan Chase & Co. The drop in production comes as purchases of the stones rise, helped by the booming economies of China and India. China alone doubled jewelry purchases since 2001 and may buy 20 percent more this year, according to www Diamond Forecast Ltd., a London-based research firm.

Diamonds have ``the best fundamentals,'' said Evy Hambro, who manages the $6.6 billion World Mining Fund in London for Merrill Lynch. ``The gap between supply and demand is much bigger relative to other commodities.''

Rough, or uncut, diamonds don't trade on commodity exchanges. Instead Johannesburg-based De Beers, which sells 60 percent of the world's uncut gems, holds 10 sales a year, known as sights, to a select group of customers called sightholders from countries known for diamond cutting, including Belgium and Israel. That leaves shares of diamond producers as the easiest way to invest in the gems.

`Very Positive'

Hambro, with 1.5 percent of his assets in diamond companies, said he will buy shares of Germiston, South Africa-based Gem Diamond Mining Corp., which goes public this year, and Toronto- based Aber Diamond Corp. Ian Henderson, who manages $2.5 billion in natural-resource assets for JPMorgan in London, said he has increased his diamond-share holdings to 4 percent from 1 percent in the past year. He declined to elaborate.

``I am very positive about diamonds, given the overall supply-demand situation,'' said Henderson. ``Of the 170 diamond companies out there, only 25 are actually producing.''

One of those is Dublin-based African Diamonds, whose shares almost tripled this year. Another is Sierra Leone Diamond Co., a Hemel Hempstead, U.K.-based company operating in West Africa, whose stock has also tripled. Shares of Petra Diamonds, a Jersey, U.K.-based explorer in Angola, South Africa and Botswana, have risen 52 percent. By contrast, the Bloomberg World Mining index of 48 companies, including OAO GMK Norilsk Nickel, the world's No. 1 nickel producer, is up 21 percent.

``There are no big mines out there in the foreseeable future,'' said John Teeling, chairman of African Diamonds, which made its first and only diamond-mine discovery two years ago in Botswana. ``We'd be very lucky to find a second.''

Retail Boom

Declining production is a boon for retailers. Consumers bought $70 billion of diamonds worldwide last year, Picton said. Retailers including De Beers and Tiffany & Co. aim to increase that figure this year with new stores from Wall Street to Beijing. De Beers plans to open 20 new jewelry stores this year and next with Paris-based LVMH Moet Hennessy Louis Vuitton SA.

``There's something about diamonds that is completely seductive for people,'' said Stephen Webster, who designed the wedding rings for singers Madonna, Pink and Christina Aguilera. ``Everything else feels second-best.''

Thirty Percent Increase

The value of rough diamonds, as the uncut stones are called, is likely to increase 30 percent in the next six years, says Picton at Manchester, England-based W.H. Ireland. His research shows that diamonds provided better returns than gold since 1948.

Diamonds, the hardest substance in the world, formed in primeval carbon rock structures known as kimberlites at least 150 kilometers (93 miles) underground. Volcanic activity brought the gems closer to the surface, and the first were found in the riverbeds of India's Golconda region. About 7,000 kimberlites have been discovered and only 15 percent bear diamonds. Since the first were discovered more than 2,000 years ago in India, the world has produced 380 tons of diamonds.

The scarcer they are, the higher the price. The average value of the 114 million carats (50 pounds) of diamonds sold worldwide each year is little more than $7 billion, according to the World Diamond Council. In 2000, when 110 million carats were produced, the value was $7.8 billion.

Sea of Diamonds Outperform Metals

``Diamonds could very well outperform base metals'' in the coming years, said Andrew Ferguson, who manages about $313 million at New City Investment Managers Ltd. in London. ``Given the huge increases in demand and the imbalances in supply, I expect good returns.'' He declined to say how much.

One threat to rising prices is the growth of synthetic diamonds. Since 1955, when General Electric Co. developed a process to develop synthetic gems for use in drilling, cutting and grinding tools, the use of non-natural gems has soared, today accounting for about half of all diamonds.

Industrial use of diamonds accounted for 25 percent of supplies by weight or 5 to 10 percent by value, according to www International Diamond. Gemesis Corp., producer of most of the world's synthetic gem-quality diamonds, said it will raise output about eightfold in 2006 from last year to take advantage of rising prices.

The rally in commodity markets, now in its fifth year, has sent prices for raw materials to records. Copper has more than doubled in price in the past year. Nickel is up 77 percent. Gold has surged almost 50 percent and reached a 26-year high in May. Prices in London were at $646.30 an ounce on Aug. 3.

``To have matched the average diamond-price increase since 1948, gold would have to be around $750,'' said the 70-year-old Picton. ``To have matched a basket of the finest, largest-quality gems, gold would have to be around $2,000.''

Few Producing diamond Mines

Some untapped diamond deposits are too dangerous to develop, adding to a shortage. Disputes over access to the gems have sparked violence in Angola and in the resource-rich Democratic Republic of Congo during the civil war that has killed more than 4 million since 1998.

Diamond investments will enjoy ``above-average'' returns in the next several years, according to Trevor Steel, who manages $600 million in natural-resource assets at Baker Steel Capital Managers in London. ``Prices of diamonds and precious metals generally are more resilient to the short-term effects of an economic slowdown compared with base metals.''

W.H. Ireland's Picton says falling production, led by declines at the biggest producers, including Rio Tinto Group's Argyle mine in Australia, the world's largest, will leave $10 billion of demand unfulfilled. The drop will occur even after Botswana boosted output 17 percent last year. The nation, the world's biggest producer of diamonds, accounts for 25 percent of the gems.

`Another Botswana'

``In order to meet the shortfall, you would have to find at least another Botswana, or better yet, two,'' said Picton, whose company is based in Manchester, England. ``It can't be done.''

Canada's Ekati mine, run by BHP Billiton, will be depleted by 2015, Picton said. Ekati, which produces about $700 million of rough gems a year, will last until 2017, said BHP spokeswoman Emma Meade in Melbourne. Rio Tinto's Diavik mine in Canada will drop ``sharply,'' Picton said. Rio Tinto said in December it will spend $910 million to extend the life of its Argyle mine to 2018.

With diamonds hard to come by, some stocks have sputtered. Shares of Gravity Diamonds Ltd., a Melbourne-based company that explores in Congo, have slumped 45 percent in the past year. European Diamonds Plc of London, which explores and mines in Finland and Lesotho, southern Africa, is down 60 percent in the past year.

``The really tricky bit with diamond-exploration companies is finding a kimberlite that is actually economically viable,'' said Sacha Borthwick, an analyst at stockbroker Hargreave Hale Ltd. in London. ``The odds of that are very low.''

Most Expensive diamonds

Global demand may rise 6 percent a year to $23 billion by 2015, Picton says.

About 1.2 billion diamonds weighing 160 million carats and worth $13.4 billion were produced last year, according to www International Diamond. Uncut diamond prices rose 3.7 percent on average last year to $84 a carat, with the most expensive pink and red stones selling for $50,000, the consulting company said.

The most expensive diamond ever sold is the 100.1 carat Star of the Season, bought for $16.5 million in Geneva in 1995 by Saudi Sheikh Ahmed Hassan Fitaihi. The largest gem ever found is the Cullinan, which was discovered in 1905 in South Africa and weighed 3,106 carats, according to London-based Diamond and Trading Company.

Finding Stones in a sea of Diamonds

Diamond miners are spending more to find the stones. De Beers plans to invest 1.2 billion rand ($175 million) in opening South Africa's Voorspoed mine, which was closed 97 years ago, and a further 1 billion rand on a project on the sea bed off South Africa's coast. In Canada, De Beers is spending C$2 billion ($1.8 billion) digging the Snap Lake and Victor mines.

``Diamond stocks have underperformed other mining stocks in this commodity bull-run,'' says New York-based James Passin, whose $500 million Firebird Global Fund has a 10 percent holding in diamond stocks. ``This is about to change.''

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