Challenges facing the Australian diamond industry

Expectations for a rebound should be balanced with the realization that this industry has faced years of declines, which include falling export volumes and export values. Efforts are being made to improve the situation, but there are still risks and challenges ahead.

While there is an insignificant degree of small-scale mining for other gems, such as sapphire and opal, Australia’s gem and diamond mining industry almost exclusively consists of Gem Diamonds (LSE:GEMD) and Rio Tinto(NYSE:RIO,ASX:RIO,LSE:RIO).

Rio Tinto production and plans

Of the two companies, Rio Tinto mines the most diamonds, producing the majority at its Argyle mine, where 90 percent of the world’s pink and red diamonds are mined.

At its prime, annual production at the mine reportedly fluctuated between 20 and 30 million carats, but it has been years since Rio has produced anything close to that amount. Argyle’s production in the past five years has tumbled from double to single digits, with fewer than eight million carats coming from the mine from 2010-11.

Rio Tinto reported that 2011 production declined 24 percent compared with 2010, citing heavy rains, lower ore grades, and maintenance shutdowns.

IBISWorld’s projections are largely based on the expectation that Argyle will again be good for 20 million carats per year once Rio Tinto’s underground development project is completed.

In 2005, Rio Tinto decided to extend Argyle’s lifespan by transitioning from open pit to underground mining, a plan that included an open pit cutback project to facilitate production during processing. This project, which aims to allow mining at least through to 2019, has faced a number of challenges.

In December, the company adjusted its assumption of the costs, and approved another $0.5 billion, deeming it necessary because of a record 2010-11 wet season and adverse exchange rate movements. The project’s budget has swelled to $2.1 billion, and full production is not expected until 2014.

Falling production volumes have been associated with this type of transition in the past, but this year Argyle is expected to produce about 13 million carats.

Gem Diamonds production and plans

Gem Diamonds owns the Ellendale mine, which is the source of half the world’s rare yellow diamonds. Like Rio, the company has also faced challenges over the past several years, including production struggles.

In Q4 2011, Ellendale’s rates of ore mined and carats recovered were down compared with Q4 2010. However, the company reported that production improved compared to the previous 2011 quarters.

Gem Diamonds began taking steps to improve operations in the latter half of last year, including major wet front end modifications. Though all planned improvements are not expected to be completed until the end of this month, the efforts appear to be paying off, as the company reported “significant improvement in production performance” in the final quarter, with the highest carat recovery of 2011 occurring in November.

But, while the company was raking in substantially more per carat from its yellow diamond agreement with Tiffany and Co. in Q4 2011 than in Q4 2010, Gem Diamondsreported that rough diamond prices had taken a hit due to the Eurozone crisis.

Money problems

A strong Australian dollar acts as a weight on diamond mining profits because diamonds are priced in US dollars. When the US dollar is stronger, sales result in more Australian dollars in the bank. The opposite occurs when the Aussie dollar strengthens.
Some easing of the nation’s currency is expected this year, but the Australian diamond industry still faces other money challenges, such as how much is being spent for its products. Achieving IBISWorld’s forecast will require healthy demand and strong prices.

2012 diamond debut

The diamond market of 2012 is not replicating that of 2011, when prices soared for more than half of the year. Instead, this year’s market is off to a lukewarm start following a correction that began unfolding in Q4 of 2011. These conditions are widely expected to remain, at least through the first quarter.

Emerging nations – especially India and China – are widely regarded as essential growth markets for diamonds, and are expected to be drivers for strong industry performance going forward. Yet there is some concern about a slowdown in these economies.

Almost all of Australia’s diamonds are exported, with the majority of Argyle production going to India. The Indian diamond market, is not especially robust. Last year, while the prices were up, the value of India’s diamond imports increased, however, the volume decreased, with Q4 showing severe weakness.

India has been grappling with inflation and a weak rupee, which has resulted in USD-priced goods becoming much more expensive. The rupee is recovering, but the Indian government is also looking for cash. One means of getting it is through the new two percent tax on polished diamond imports announced last month.

How this tax will impact the market remains to be seen. During the first eleven months of 2011, India’s polished imports rose to $18.8 billion.

Since India is a manufacturing hub, much of what flows in heads back out to other other markets.

Asian buyers appear laid back recently. Chinese sales were steady for last month’s new year festivities. However, concerns about a potential economic slowdown are believed to be behind cooling sentiments among suppliers and consumers there.

Likewise, the US is the largest diamond consumer. Demand was satisfactory for the December holiday season, but with festivities gone, enthusiasm for diamond purchases appears to have also simmered down.

The Luxury Consumption Index shows that luxury consumer confidence slid in January, and average spending was also reportedly down in Q4.

The Eurozone crisis has weakened the appetite for diamonds in that region.

Lately discussions about the diamond market are accompanied by the word “caution.”  The shakey demand picture illustrates a good reason why.

“Diamonds are a luxury product,” IBISWorld says, and “demand tends to fall disproportionately heavily during times of economic downturn and rise sharply when economic conditions and consumer confidence improve. Investors should factor this into their decisions.”

Diamond outlook

With increased production and rising prices, IBISWorld foresees a profitable turnaround for Australia’s industry. Diamond and gemstone mining sits at the top of its list of growth industries, and is expected to rake in nearly $600 million this year.

Rio Tinto warns of significant risks related to the Eurozone crisis, the threat of contagion to developing nations – especially China – and the potential for financial crisis. However, the company also expects a revival in the diamond market as excess stocks are cleared, noting that medium run consumer demand looks positive.

Securities Disclosure: I, Michelle Smith, hold no direct investment interest in any company mentioned in this article.

Read at Resource Investing News.