Follow the yellow brick road: a journey into the world of coloured gemstones

Neither gold nor copper were being pulled from the mines. Instead, something far more precious to the legendary source of beauty and power the miners served, and from whom the exhausted Cleopatra Mines now take their name.

Emeralds.

Cleopatra is said to have loved emeralds above all other luxuries, and they remain a lasting symbol of her legacy. She was known to drape herself in garments laced with the piercing green stone, favoured visitors bearing the gem as gifts, and bestowed emeralds carved in her likeness to visiting dignitaries. The story goes that she split her largest stone in two – giving half to her lover Mark Antony, the Roman general and politician, to take into battle and keeping the other half by her side.

There was nothing prized higher by the last Pharaoh of Egypt.

POWERFUL SYMBOLS

For nearly five centuries gemstones have been synonymous with wealth, power, luxury and royalty.

Cultures around the globe have, and continue to, attribute mystical ability to gems – from the power to heal, to invisibility and the ability to foretell the future.

Ruby, known in Sanskrit as ratnaraj, means “King of Gems.” Burmese warriors believed that if rubies were inserted under their skin, they would become invincible in battle.

To this day Princess Kate, Duchess of Cambridge, wears an elegant sapphire engagement ring on her left hand, a stone passed down from the late Princess Diana to her son William.

Before there were designer purses, fast cars, and priceless paintings there were gemstones – the perfect union of artistry and natural phenomenon. The physical embodiment of luxury.

However, over the last century, coloured gemstones have become a vestige of the past, all but forgotten by the modern consumer.

After losing ground to fine art and luxury brands, coloured gems were surpassed by diamonds in the mid-20th century under the watchful eye and incredible focus of De Beers and the Oppenheimer family. After centuries as the world’s premier luxury asset, coloured gemstones appeared destined to become an overlooked, underappreciated specialty item.

That is, until recently.

Over the past six years, there has been a slow revitalization of the coloured gemstone industry, and it has been led by one name: Gemfields.

Note: I’ve written this article out of interest in Gemfields and the coloured gemstone space. I have received no compensation from Gemfields, and I am not a shareholder in the company. However I may purchase shares at some date in the future.

DRIVEN BY PASSION

I first met Ian Harebottle, CEO of Gemfields PLC, in early 2012 over a Skype call. I had responded to a job advert for a role at Gemfields, thinking my extensive site experience (a grand total of 18 months at the time) made me the ideal candidate to work at the up-and-coming miner’s head office in London. Mr. Harebottle had other plans. He was looking for enthusiastic engineers and geologists to work on site in Zambia and later, Mozambique.

Mr. Harebottle emphasized that candidates must meet one criteria: passion. He said he was looking for smart people that were truly passionate about what they were doing.

At 25 and having spent the better part of the last year living in a yurt in Mongolia, I was considerably more passionate about spending some time in a city. We wished one another well and parted on good terms.

Over the past several years I’ve often thought of that conversation, and Mr. Harebottle’s insistence on passion, particularly as I’ve watched Gemfields’ explosive growth and string of successes.

On Monday for instance, Gemfields announced that an auction of emeralds from its Kagem mine in Zambia had raised US$19.2 million, exceeding all expectations.

Mr. Harebottle seems to practise what he preaches: speaking with him, it is immediately clear he is passionate about the gem space, his company, and life. Even over the phone he radiates excitement, waxing poetically about his love of gemstones and spouting phrases such as “I believe in the psyche of every human being exists a love for colour!” An avid motorcyclist, he is nearly bursting with a tightly coiled enthusiasm for everything we discuss.

But you can’t understand Ian, Gemfields, or the coloured gemstone industry until you understand gems. To do that, we must start at the beginning with that most famous, and infamous, gem: Diamond.

GEMSTONES AND THE RISE OF THE DIAMOND

“It’s always best to start at the beginning and all you do is follow the yellow brick road”
– Glinda, the Good Witch

In 1947 advertising writer Frances Gerety was working late at her desk on a series of ads. Exhausted after a long day and ready to head to bed, she said to herself “God, send me a line.” Scribbled down a few words and went off to sleep (How Diamonds Became Forever, The New York Times; May. 2013 ).

Whether by divine intervention, genius or blind luck unbeknownst to Ms. Gerety, she had just crafted what would be one of the most prolific lines in advertising history. She had initiated a campaign that would become synonymous with love, marriage and luxury; and help to launch an industry that would change the face of luxury goods around the globe: “A Diamond Is Forever.”

Until the mid-1940’s diamond was just another gemstone sharing the market, relatively equally, with coloured gems such as: Ruby, Emerald and Sapphire. Precious stones, or gemstones, were thought to be the domain of the rich and famous. Too expensive for the middle class and destined to adorn the fingers and necks of royalty and movie stars.

Gems were typically discovered and mined in the classic “gold rush” scenario. A local rock hound or geologist would stumble upon a small deposit and gemhunters from around the globe would ride into town, pick the deposit clean and quickly move on. Little structure or organization existed in the industry and gems were considered such a rarity that they were out of reach for the average consumer.

That all changed in the 1870s in a small town in South Africa known as Kimberly.

Here, on the De Beers family farm, massive diamond bearing pipes (later known as kimberlites) were discovered. This time, instead of being picked clean, the pipes were purchased and consolidated by the infamous Cecil Rhodes (and later the equally notorious Oppenheimer family) – thus birthing De Beers Consolidated Mines, Ltd.

De Beers’ genius lay in their ability to consolidate the industry and form a monopoly. It won them complete control over diamond mining, sales and distribution.

Once this happened, however, they quickly discovered an inconvenient fact:

Diamonds are not that rare.

The Oppenheimers, undeterred, proceeded to combat this issue by controlling the supply and limiting the number of diamonds to reach the market each year. A feat only made possible when you own all of the mines.

The next step was to create a market and drive the price up, hence the employment of Ms. Gerety, whose famous words convinced millions of newly engaged young women that they deserved a diamond ring and every hopeful young man that he should part with 3 months’ salary to obtain a hard shiny rock.

This combination of consistent, controlled supply and ingenious marketing turned the diamond into the world’s pre-eminent gemstone.

An unfortunate consequence of this was that the diamonds’ coloured counterparts were left to adorn figures of the past.

However, not everyone forgot about coloured gemstones, and the Gemfields team has set out to restore them to their former glory.

“Pay no attention to that man behind the curtain! ” – The Wizard of Oz

Talking to the Gemfields team and seeing their passion for their work, it often feel like they are “on a mission from God.” And they are on a mission, but the entity behind the scenes is a (slightly) less impressive figure: Brian Gilbertson, the CEO and founder of private equity group Pallinghurst Capital.

If you haven’t heard of Mr. Gilbertson you’re not alone. His ability to remaining relatively anonymous is astounding given his track record in the mining industry.

After a stint designing missile systems in Paris, Mr. Gilbertson started his mining career with JCI, a major De Beers shareholder, before being poached by Gencor in 1988. He quickly rose through the ranks and eventually headed the company.

In 1994, under Mr. Gilbertson’s leadership, Gencor purchased Billiton, a company that had been around since the 1800s. Gilbertson quickly turned Billiton around and spun it out just three years later. The new Billiton would go on to merge with Australian miner Broken Hill Properties in 2001. The resulting behemoth became BHP Billiton, the world’s largest mining company; of which, incidentally, Gilbertson was CEO (Brian Gilbertson: The Industry’s Godfather, Global Mining Observer, Oct. 2014).

To say Mr. Gilbertson is a man who sees opportunities where others do not is an understatement. He has a reputation for finding overlooked potential and delivering on his vision.

Upon identifying the coloured stone space as an “overlooked industry” in 2007, Pallinghurst decided it was too good of an opportunity to pass up and proceeded to acquire 75% of the Kagem emerald mine in Zambia (the government maintained ownership of the remaining 25%).

In 2008, with the Kagem mine as its primary asset, Gemfields was born. Gilbertson brought in Harebottle and his team to run the show; of which Pallinghurst retains approximately 48%.

HOW DOES THIS ALL WORK?

“No thief, however skillful, can rob one of knowledge, and that is why knowledge is the best and safest treasure to acquire.” – Glinda the Good Witch

To be clear: for all intents and purposes, gemstones are useless.

They are a luxury good, and with the exception of industrial-grade diamonds, they serve no practical purpose. All value they possess is perceived by the market or the individual. There is perhaps nothing teetering higher on the apex of Maslow’s hierarchy of needs then a gemstone.

However …

They are rare and they are beautiful. They have captivated our imagination and symbolized wealth and luxury throughout history, and unlike many luxury goods their durability allows them to stand the test of time (measured in millennia as opposed to centuries or decades).

They also represent an interesting niche in the mining and commodities space.

Unlike base metals they are not something we need to support our way of life, and unlike gold bullion they are not used as a store of wealth to support and balance our global economies. Unlike nearly anything else society mines, their value is subjective, and as such can be created.

As long as people have wealth to spend, they will want beautiful things, and given our multi-millennial preoccupation with gems it is safe to assume that demand will not be going away anytime soon.

“You’ve had the power all along my dear.” – Glinda the Good Witch

The Gemfields model is simple: Plagiarism.

They intend to replicate, and improve upon, the De Beers diamond model in the coloured gem space. Mr. Harebottle put it to me simply: “We did a market analysis, we saw the opportunity, and figured there is no point in reinventing the wheel. We just try to avoid the mistakes and do the good bits even better.”

The process consists of three steps: Consolidate, Evaluate, Market.

CONSOLIDATE

The vast majority of gemstones are purchased for jewelry, with buyers intending to use them to create “lines” of products. Whether designing engagement rings, necklaces or earrings, most jewelers intend to create hundreds or thousands of identical pieces to sell to consumers. To do that they must be able to ensure predictable, consistent supply chains.

Supply chains that will get them the stones they need when they need them.

Consolidation was central to De Beers’ success. It is also what has, historically, been lacking in the coloured stone space, and has thus allowed the diamond to capture the market.

Because high-quality coloured gems are many times rarer than diamonds, consolidation and reliable supply has been difficult to achieve.

Difficult, but not impossible …

Gemfields’ Kagem mine currently produces around 20% of the world’s emerald supply and their share of the market is expected to grow with recent acquisitions in Colombia. Additionally, they are producing as much as 20% of the world’s rubies at their Montepuez mine.

Consolidation enables Gemfields to sells their stones via an auction system, which is not only beneficial to themselves but to the space as a whole.

Gemfields holds separate ruby and emerald auctions several times per year and attendance is selective. Receiving numerous requests to attend a given auction, invites are typically only extended to a select few.

Mr. Harebottle emphasizes the importance of selling to the right buyers, groups that are experienced working with coloured gems, and have shown commitment to expand the space. As he puts it: “Coloured gems are so incredibly rare that they need to be handled perfectly. Handled by serious people, like ourselves, that share the vision and can champion coloured [stones] for the benefit of all the other producers and the rest of the industry.”

Selecting a small cohort is also essential in ensuring that each buyer has enough time to examine the stones, get to know the product, and make the right bid.

The rough gemstones are first divided into hundreds of different quality grades (size, color, clarity, etc…) and then into different “schedules” or lots consisting of gemstones of varying quality grades that will support production runs of similar product lines. Buyers must make silent bids on an entire schedule; while only the most exceptional stones are sold individually.

This is perhaps a more progressive (and humane) version of the traditional De Beers package buying system, where an invitee was presented with a package of diamonds at a set price. He could then either choose to purchase all of the diamonds in the package or none, but if he walked away he risked never being invited back.

Gemfields’ sheer quantity of stones has allowed them to be the first to apply this system to the coloured gemstone space. Additionally, this model ensures that jewellers will receive similar quality stones in quantities great enough to design their product lines around (and perhaps most importantly design their marketing around). Although this system may irk the small-scale buyer or those who don’t receive an invite to the auction, it is on the whole beneficial to the space and helps to expand the market.

And as Mr. Harebottle points out: Gemfields is not the only company selling coloured gemstones.

EVALUATE

The 4 Cs are the universally recognized diamond grading system: Colour, Cut, Carat and Clarity. This system, created by De Beers, seems on first glance to be an excellent system for customers to understand the value of a potential purchase and pay accordingly … but this is only half true.

Originally there was only one C: Carat (1 Carat= 200 mg). The carat or size of a stone was all that consumers cared about and it was used to determine the value of a stone.

Then, in the early 1950s, De Beers created the other 3 Cs in a move to maintain their iron grip on diamond supply.

Around this time diamonds had been discovered in Russia in massive quantities. Because De Beers no longer owned most, if not all, of the world’s mines, they were in danger of losing control of the supply and pricing of diamonds.

Instead of attempting to gain control of the Russian mines, they simply purchased their output – smaller diamonds, but of a clearer variety than those produced in South Africa. (The Incredible Story of How De Beers Created and Lost The Most Powerful Monopoly Ever, Business Insider, Dec. 2011)

Left with the need to sell a mountain of tiny diamonds, De Beers came up with, and marketed, the 4 Cs. Thus increasing the value of the small but clear (aka Clarity) Russian diamonds.

One of Gemfields’ most critical moves, which has set them apart from the competition, is the creation of a comprehensive coloured gemstone classification system. It’s something they are only able to do because they control such a significant portion of the market.

Mr. Harebottle is quick to point out there is no such thing as a better gemstone. They are simply different, and as long as the customer loves his or her purchase then Gemfields has done their job right.

There are, however, more expensive gemstones, and this is predominately a factor of rarity. Larger gemstones are rarer than smaller ones, intense colour is rarer than weaker colours, and both drive up a gem’s value.

An example of this is seen in ruby, where “pigeon blood” red is the premier colour, fetching prices multiple times that of a less-rare variant of the gem.

Gemfields’ rough grading systems for both emerald and ruby were developed by their head of global sales, Adrian Banks (Gemstones on Jermyn Street: White is a Colour, Global Mining Observer, Oct. 2014). The emerald system, for example, consists of several steps:

• First, the gems are divided by size into six categories ranging from 4mm to greater than 31mm;
• They are then subdivided by colour with stones of similar hues and intensities grouped together;
• Next, stones are divided by transparency;
• And finally, they are separated based on defining traits of individual stones such as how the stone will be cut and consistency of colour.

The system allows Gemfields to supply buyers with a level of consistency in supply and value never before seen in the market. The effects of this system are twofold.

Not only can it be, in addition to marketing, largely credited with the consistent increase in price per carat Gemfields has seen at each auction, it has a trickledown effect on the entire industry. It allows consistency in pricing and confidence in supply to develop over time, with each consecutive auction bidders develop a sense of the prices expected to purchase a lot of a given “quality” of gemstones, in turn allowing them to reflect this cost in the pricing of their jewelry and products.

It also provides Gemfields with tremendous influence over the industry.

MARKETING

Mr. Harebottle considers Gemfields to be a “luxury miner,” possessing the skillsets of the best mining houses in the world – but also understanding how to promote and market their product.

There are few better ways to describe Gemfields’ aptitude for marketing than this:

That is actress/model Mila Kunis in an emerald campaign; she is Gemfields’ official brand ambassador. Her support does not come cheap however, commanding a considerable price tag with a third of Gemfields marketing budget committed to the Mila campaign and the associated marketing capital (ie. advertising space, photography, videography, etc). But Mr. Harebottle couldn’t be happier about the relationship and believes Ms. Kunis to be the perfect fit for Gemfields.

And, it would appear the market agrees …..

Gemfields has managed to increase both the supply (i.e. the quantity of gems hitting the market) and the price per carat of their stones, both ruby and emerald.

Take a moment to consider how remarkable this is, as it flies in the face of conventional supply and demand. When I mentioned to Mr. Harebottle that he had set himself the formidable task of running a mining company while simultaneously creating the market for his product, he put it a different way: “The market has always been there, it just became forgotten. We’ve simply managed to help reinvigorate or resuscitate the market.”

The truth is, engaging Ms. Kunis is only the tip of the iceberg. Gemfields’ marketing strategy, headed by Anna Haber, is prolific. From magazine ads to fundraisers and bespoke parties, they are everywhere in the coloured gemstone and luxury goods space – and I for one cannot think of another miner that’s graced the pages of Vogue Magazine lately.

Calling Gemfields ambitious is an understatement.

In February 2013 they took it a step further with the purchase of the Fabergé brand in a US$90M paper deal. If you are wondering why you’ve heard that name before, it’s because of these:

The famous Fabergé Eggs. House of Fabergé started in St. Petersburg in the mid 1800s and was the official goldsmith to the Russian Imperial Court, producing eggs for the Tsars to give to their wives for Easter.

The Fabergé name, one of the most iconic jewellers in the world, is now being utilized by Gemfields to promote coloured stones in art and jewelry.

The acquisition of a brand-name retailer is a move we’ve seen before in the diamond industry with Aber Diamonds (now Dominion Diamond’s) purchase of luxury brand Harry Winston. Interestingly they’ve since sold Harry Winston to focus purely on mining.

The question: Is Gemfields overextending themselves by stepping into the retail space?

Possibly. Despite revenue of nearly US$9M in 2015, Fabergé has run at a loss of over US$15M the past two years and likely will for several more.

But my thoughts are: likely not.

Unlike diamonds, which already have an established market and consistent prices, coloured gems need focused aggressive marketing. Controlling a famous brand like Fabergé is an excellent way to do that.

Perhaps it will make sense to sell off Fabergé down the road once the coloured stone market has stabilized – only time will tell.

But given that Gemfields was able to wrestle Fabergé away from Mr. Gilbertson (who had previously taken it from Unilever), as well as the fact that it hasn’t hurt their market capitalization, and that they undoubtedly possess the most capable coloured gemstone teams in the world – it appears to makes sense.

GEMFIELDS TODAY

“There’s no place like home.” – Dorothy

Today Gemfields PLC (GEM-AIM) has a market capitalization of US$342M (£227M) and is trading at just over US$0.60 (£0.40), nearly 10X where it began six years ago.

Highlights from the last year include:
– Revenue of US$171.4 million;
– After-tax profit of US$12.3 million;
– US$28 million in cash (30 June 2015); and
– A gemstone inventory on hand, estimated at a production cost (considerably below the expected selling price) of US$101.1 million.

The Gemfields portfolio is expansive, and growing quickly. It consists of emerald, ruby and amethyst projects in Africa, the recent acquisition of two emerald projects in Colombia, licenses and partnerships in Sri Lanka, Ethiopia, Madagascar and Colombia, a trading arm, and Fabergé.

Note: Gemfields financial year ends June 30th. For simplicity throughout this report a given financial year has been referred to as the calendar year of its later half.

EMERALD

The Kagem emerald mine is Gemfields’ flagship project, first acquired by Pallinghurst, and what Mr. Harebottle refers to as the company’s “foundation and first love.”

And to be fair, they have every reason to love it.

With outputs constantly above 20M carats annually, Kagem has produced on a massive scale and is singlehandedly responsible for at least 20% of the world’s emerald supply.

Zambian emeralds are distinct from the more well-known Colombian variety; possessing a slight bluish hue. And despite somewhat humble beginnings, the distinctive Zambian emerald has caught on thanks to Gemfields aggressive marketing… and, no doubt, Ms. Kunis.

This ramp-up of value culminated at auction last year when the average price per carat price hit an all-time high of US$65.89 for high-quality rough emeralds.

In the past year Gemfields has poured about US$35M into Kagem; providing new equipment, and improving facilities and infrastructure. Kagem’s processing plant hit record levels of activity, and the capacity of the wash plant, a key piece of infrastructure, is in the process of being doubled.

And more to the point: It would appear Kagem is only getting started.

Earlier this year SRK Consulting completed an updated resource/reserve estimate on Kagem predicting a 25-year mine life, an NPV (10% discount) of US$520M, and nearly 2 billion carats in-situ.

Further confirming that Kagem has a long, bright future in front of it are the results from Gemfields last low quality emerald auction released earlier this week, which brought US$19.2M into the company.

Though perhaps the most interesting thing about Kagem is it’s not even Gemfields’ most exciting project.

RUBY

“When I get those ruby slippers my power will be the greatest in Oz.” – The Wicked Witch of the West

Ian calls Gemfields’ Montepuez ruby mine a “once in a lifetime” discovery.

And he may be right.

Prior to Gemfields, Montepuez was a reserve owned by private Mozambican company Mwiriti. After discovering red corundum on the grounds, the owners went shopping for potential partners at some of the world’s premier mining houses.

In late 2011 they settled on Gemfields, who picked up 75% of the project for only $2.5 million, with Mwiriti controlling the remaining 25%.

A recent feasibility study completed by SRK predicts:
– A 21-year mine life expected to produce over 430m carats;
– A projected LoM cash flow of $2.76 billion;
– Post-tax NPV (10% discount rate) of $996M;
– An IRR of 311.7%

Which is pretty amazing, especially if you consider the fact that the mine essentially paid for itself in under three years.

Gemfields’ inaugural ruby auction in June 2014 brought in $33.5M, all but recouping the $34.5M spent to date on purchase price, capital and operating costs (Gemstones on Jermyn Street: White is a Colour, Global Mining Observer, Oct. 2014).

Gemfields ruby auctions are still in their early days but appear very promising. The first “tester” auction, which sold gems of mixed quality, was completed in January 2014. This was followed closely by two high-quality and one low-quality auctions over the next year.

Average per-carat prices range from US$688.64 (Gemfields highest ever) at the Dec. 2014 high-value ruby auction to US$4.02 at the April 2015 low-value ruby auction.

However, Montepuez has faced ballooning operating costs that have nearly tripled from 2014 to 2015, resulting in only a 40% increase in the number of carats produced.

The cost of producing a carat of ruby at Montepuez has gone from US$1.22 to US$2.57 in the past year. If costs continue to grow, this will become a major issue.

But, before sounding the alarms it’s important to note that Montepuez is still very profitable, bringing in over US$45M in revenue at a cost of less than US$31.5M.

Perhaps most importantly: this is a project that is currently in the bulk sample phase (ie. very early in the mining lifecycle), and one that has undergone a major (read: expensive) ramp up.

The first thing to remember is that gem mining is not only tricky, it’s volatile. Unlike traditional metal deposits, gems are not evenly dispersed throughout the orebody. Instead they often occur in clumps or highly mineralized pockets, similar to the “nugget effect” sometimes seen in gold deposits. Because of this, planning is difficult, production more sporadic and some years will inherently be better than others.

Fluctuating costs and production are thus part of the nature of gem mining and are to be expected as Montepuez progresses into full steady state production, and throughout its life.

Second, Gemfields annual report claims that even though the grade of the mined material has decreased, with fewer carats produced in 2015, the value of the material is considerably higher. This is a phenomenon that is unique to gemstones; where value can increase exponentially with the size and rarity of a stone.

Put simply: One 20-carat gem may be worth many times what 20 1-carat gems are worth.

Only future auctions can confirm this.

With 500 people on site at any given time, Montepuez is quickly moving towards full production. Having sunk nearly US$10M of capital into the mining fleet in the past year, Gemfields has increased operating capacity by over 90%. Gemfields next intends to increase processing capacity by 50% to 150 tonnes per hour, and could potentially build a second wash plant, bringing capacity to 320 tonnes per hour in the future.

Runaway operating costs are something that investors need to watch closely and hold the company accountable for.

But if Gemfields stabilizes and makes good on projections in the feasibility study, Montepuez will not only be a massive win, it will quickly become the jewel of the Gemfields portfolio.

ADDITIONAL PROJECTS

Kagem and Montepuez are Gemfields’ highest-profile projects and make up the bulk of the revenue stream, but they are far from the only assets on the books.

In addition to emerald and ruby, Gemfields has the Kariba amethyst mine in Zambia, which produces 40% of the world’s amethyst.

They have a lucrative sapphire trading arm in Sri Lanka that purchases rough sapphire from reputable parties, as well as an operating interest in several exploration properties throughout the country.

Gemfields also owns a majority interest in an Ethiopian company that is conducting emerald exploration on a 200 km2 stretch of property.

And they are currently putting licenses in place through a subsidiary in Madagascar.

Most recently, Gemfields acquired two projects in Colombia, most notably the Coscuez emerald mine in the famous Muzo district. Coscuez is one of the world’s most famous emerald mines and has been in operation for over 25 years. Gemfields picked up Coscuez for US$12.5M in cash and US$2.5M in shares in September 2015.

When I asked Mr. Harebottle how he intended to navigate the notorious quagmire that is gem mining in Colombia and the various nefarious elements he can expect to encounter there, he was unperturbed. He stated that Gemfields intends to bring its unique combination of transparency, responsibility and expertise to the region. An influx of capital doubtlessly won’t hurt either, in an area where mining methods have changed little in the past 100 years, and profits have a reputation of ending up in the pockets of cartels rather than being reinvested into projects.

What is most important about Coscuez is that it will finally give Gemfields access to the quintessential Colombia emerald. While Zambian emeralds have seen a steady increase in value under Gemfields’ mindful stewardship, the Colombian variant remains the benchmark for the stone – maintaining the greatest renown and fetching the highest prices.

Gemfields has generated significant revenue year over year since the company was formed in 2009.

That said, the biggest issue Gemfields faces is that profits are down by nearly 25% from 2014 despite increased revenue. As a result, the company’s share price has been crushed, dropping 37% in the last 2.5 months.

But let’s take a closer look.

Gemfields itself attributes the decrease in profit to higher costs and lower gross margins. As noted earlier, mining gems is difficult and notoriously volatile.

Examining Gemfields’ “gross profit” provides us a better understanding of the profit made by a given mining operation after taking into account the costs of running that operation. This does not reflect general administrative costs (marketing, legal fees, head office expenses, etc.).

Gross Profit = Revenue – Cost of Goods Sold

Here we see a decrease of only $95,000, or 0.1%, from 2014 to 2015.

This suggests that the increased costs are being incurred in areas outside of the operations. A quick look through Gemfields’ financial statements shows us that sales and general administration costs are up 15% in 2015.

In fact, marketing and advertising costs alone (an area few miners need to worry about) have increased by nearly 20%.

If you think about it, this makes sense.

In the last 3 years, Gemfields has:
– Acquired a second emerald mine in Colombia;
– Acquired and operated Fabergé (at a loss);
– Brought the Montepuez mine through feasibility and completed a bulk sample;
– Run a prosperous trading arm;
– Developed partnerships in Sri Lanka, Madagascar, and Ethiopia;
– Hired actress Mila Kunis as an “ambassador” to promote their gems.

They have also remained one the top performing mining stocks in the world over the past few years.

Rising corporate costs will need to be halted at some point, and they are really only acceptable when they bring about accretive growth.

But I believe they have.

To me, moves like this indicate a management team that is thinking beyond quarterly or annual earnings. They are doing exactly what they’ve said they would do – building the world’s leader in coloured gemstones and creating a fully integrated mine-to-market machine.

THE COMPETITION

I would be remiss if I did not mention Gemfields’ competitors; they are, however, few and far between and many of those that do exist are notoriously secretive. The coloured gemstone industry is largely a black box controlled by private organizations and individuals. These vary in form, ranging from small-scale artisanal miners throughout Africa, Asia and South America, wealthy private companies, and often an almost (and sometimes literally) cartel-like structure in Brazil and Colombia.

The result? It makes it very difficult to determine what is going on in the industry as a whole.

However, at the time of this writing I could find only two other publicly traded coloured gemstone companies:

True North Gems (TGX-V) is a Vancouver-based junior exploring for rubies. True North is currently in the early development stage of their Aappaluttoq mine in Greenland. By all accounts this project has a lot of potential and is one to watch. It may, however, be some time before commercial production is achieved.

Richland Resources (RLD-LSE) owns and operates a sapphire mine in Australia, as well as an online gem retailer selling predominantly sapphires and tanzanite.

Gemfields’ market capitalization is currently nearly seven times that of their publicly traded competitors (combined) and they control a market share that is an order of magnitude greater.

Beyond employing a very capable team and being by far the best capitalized (thanks largely to Mr. Gilbertson), Gemfields is far and beyond the most aggressive marketer and promoter I’ve seen in the space.

WHAT’S NEXT?

“Everything you were looking for was right there with you all along.” – The Wizard of Oz

When I asked this question in our interview, Mr. Harebottle told me I sounded like a banker (as he sees them always looking for more blue-sky potential) and said: what’s next is to make sure that all of Gemfields’ operations, and Fabergé, are running optimally.

And, of course, that is the right thing to do.

But… I don’t fully buy it.

Since our conversation Gemfields has bought the Coscuez emerald mine in Colombia. They’re nursing relationships and licences across Asia and Africa and they’re putting in a concerted effort to expand Fabergé.

This is a group that’s hungry for projects and growth – perhaps picky, but certainly hungry.

I don’t know what’s next on Gemfields’ plate, but I am certain the company is not done yet.

Although he didn’t mention it to me personally, in researching this article, I read other interviews where Mr. Harebottle insinuated ambitions at a someday merger with De Beers.

On first glance, this seems absurd.

But a lot can be said for momentum, and Gemfields has it in spades. De Beers, on the other hand, no longer appears to have much at all. The company has struggled to maintain its grip on the diamond world in recent years as competition increases, and De Beers is now navigating the realities of lower rough diamond prices.

The diamond industry is facing some serious headwinds as global economic growth continues to stall.

There are notable exceptions, of course. Such as when a Chinese billionaire makes arecord-breaking (US$48.4M) blue diamond purchase for his 7-year-old daughter. And the recent discovery of a 1,111-carat diamond by Lucara (the largest diamond recovered since the Cullinan stone, which was cut to make the Crown jewels) has already sent shockwaves through the industry and will be sure to pique consumer interest.

But perhaps stumbling diamond prices are the opportunity that Gemfields (and coloured gemstones) have patiently been waiting for?

The gemstone industry can be likened to a ship, and for it to work properly it requires a captain – why not Gemfields?

I’m reminded of the biography of Steve Jobs, where author Walter Isaacson recounts a man insistent on perfection and so attentive to detail that he demands all Apple products be equally beautiful on the inside as the out. So that if a customer were to pry off the back of an iPhone or Mac, they would see that the components were arranged neatly and orderly, and that the circuitry was beautiful.

To most, this would – and did – seem absurd. But that was the level of commitment required to build the most valuable company on earth.

In many ways, I see the same precision of action and encompassing obsession at work in Gemfields. When I asked Ian what makes them special he summed it up simply: “I don’t think working at Gemfields is a job for almost anyone on our team; our staff loves what they do and for most of them it’s their passion, so our people tend to go way way beyond what’s expected.”

Take a look at their website and you’ll see the immense thought they’ve put into its design. In fact, even their financial statements are a work of art.

This may be unimportant. A waste of time and energy.

But to me it speaks to something bigger. Because when I see a company that puts this much care into a financial statement, I think about the attention they must be devoting to their operations, to their community engagement and government relations, to their sales and marketing – to the things that matter.

That is why I am impressed with Gemfields, and to what I attribute their success in a space where many before them have failed. There will undoubtedly be challenges and hurdles ahead, but Mr. Harebottle and his team seem well on their way to creating a truly remarkable industry outlier.

And while success can never be assured, we would all do well to remember what lies at the end of the yellow brick road …

Jamie Keech