TORONTO (miningweekly.com) – As the global diamond industry sobers from a hangover of expected market growth that did not happen, Canadian producers are perhaps best positioned to weather the downturn, given the superiority of the country’s diamond projects.
Since the global economic downturn of 2009 and up to the middle of last year, the midstream segment of the diamond industry – the cutters, manufactures and wholesalers, mainly in India – overspeculated on future demand by aggressively expanding businesses, despite market indications not supporting investment, independent diamond analyst and consultant Paul Zimnisky told Mining Weekly Online in an interview.
Banks accommodated these aspirations by providing the capital. The upstream industry – the miners – happily provided more product at higher prices to meet the midstream’s unsubstantiated demand.
“This incongruence finally caught up to the industry towards the end of last year. There is currently an oversupply of low- to mid-quality polished [diamonds] in the market, and the midstream segment is overleveraged and can no longer substantiate buying rough at the same quantity and price they were before,” Zimnisky explained.
The world’s three largest producers – De Beers, Alrosa and Rio Tinto – had all taken measures in reaction to the situation, by cutting supply, or prices, or a combination of both, which, over time, could eventually normalise conditions, if history was any indication, he said.
Despite current market conditions affecting the industry as a whole, the Canadian operators included, Zimnisky believed Canada was the best-positioned jurisdiction in the industry, given the quality of the projects.
“Looking at the Northwest Territory’s (NWT’s) Ekati and Diavik mines, for instance, they are still quite profitable projects, even in a weaker price environment. I think Dominion Diamond, which owns 89% of Ekati and 40% of Diavik, could generate almost $250-million in free cash flow next year and almost double that the following year, using what I would consider a conservative diamond price. The company’s market cap is only $750-million,” he noted.
The two diamond mines currently being built in Canada, De Beers and Mountain Province’s Gahcho Kué, also in the NWT, and Stornoway Diamond Corp’s Renard project, in Quebec, were already fully financed, meaning they would not need to raise money in the weaker investment environment.
Further, Mountain Province’s exploration spinout, Kennady Diamonds, just successfully closed a C$48-million financing in October, which would cover the company's activities through to 2017, which, Zimnisky noted, was impressive relative to the company’s C$130-million market capitalisation.
In the wake of depressed markets, De Beers responded by cutting its 2015 diamond output by 12% since the start of the year. The initial full-year guidance was 32-million to 34-million carats, which was reduced to 30-million to 32-million carats in late April, and then cut to 29-million carats in October.
This compared with full-year output in 2014 of 32.6-million carats, and 31.2-million carats in 2013. The company specifically cut production at two tailings operations in Africa and also cut prices about 10% in August, while allowing contracted buyers to defer purchases this year.
Meanwhile, Russia’s Alrosa was building inventory, rather than curtailing production, Zimnisky advised. The company had reduced prices by about 15% this year. “But, they have actually projected a production increase of 5% to 38-million carats this year, which should make them the world’s largest producer by volume and value in 2015.”
Rio Tinto had also intentionally cut its production plan at its Argyle mine, in Australia, by about 10%, in response to the weak price environment.
The smaller diamond producers, such as London-based Petra Diamonds, should benefit as global supply comes off, but they were not pressured to cut their own production, the analyst pointed out.
According to Zimnisky, the biggest risk to the industry at the moment was that the current weak price environment lasted longer than expected. “If China weakens the yuan again, which it may have to in order to meet its [gross domestic product] forecast, a consequently stronger US dollar could further hurt global diamond demand in the coming year,” he stressed.
More specifically, in Canada, first production at Gahcho Kué was planned for the middle of next year; if the timeline there got pushed back for any reason, it could temporarily sour investment sentiment for the industry, he advised. However, everything was currently on schedule.
Zimnisky pointed to De Beers’ most recent sale, which concluded on November 6 and which was seen as the worst received in years. “I think it’s a sign of capitulation and can be indicative of a near-term bottom in the current rout.”
The diamond industry had a good history of protecting prices. Zimnisky saw a changed market landscape today without a De Beers monopoly and the three largest producers, producing almost two-thirds of global output, had all taken action to support prices this year. “I think the result will become apparent by the middle of next year – the 2016 holiday buying season,” he said.
Zimnisky expected average rough diamond prices for 2016 would be higher than current levels, which were now at multiyear lows.
The analyst explained that the largest boost in diamond demand over the last two decades came from a surge in Chinese and Indian luxury consumption, as those economies reformed, and as the populations adopted diamond engagement ring giving in those countries.
“While that demand shock has now normalised, given the relative size of those economies, they will still continue to have a tremendous amount of impact on global diamond demand growth, albeit at a less accelerated pace. The industry’s largest market, the US, has remained relatively stable post the economic downturn seven years ago, providing a demand backdrop for the industry. If that were to continue in the short-to-medium term, it should be supportive of prices as global supply comes off in the coming months,” he noted.
Looking further out, China’s reformation of its one-child policy could positively impact demand in coming decades, for example, but it would take “something like an economic revolution” in Africa to see a repeat of what played out over the last couple of decades in Asia, which Zimnisky expected could still be 25 years or more away.
“I think the biggest risk to the industry is the Millennial and younger generations in the West not accepting diamonds as an essential component of the engagement process,” he said.
Thanks to several growth projects moving up the value curve, Canada could represent about one-quarter of global output by 2018, putting it in line with the world’s two largest producers, Russia and Botswana. Canada currently represented about 15% of global production by value, compared with Russia and Botswana’s 25%, each.
Gahcho Kué, Renard and Ekati’s Misery pipe were expected to be the main drivers of Canada’s diamond production growth over the next three years, Zimnisky advised.
He regarded the diamond exploration industry in Canada as being relatively healthy. In addition to Kennady, Peregrine Diamonds was active in Nunavut, with the results of a bulk sample from its Chidliak project due around the New Year, followed by a preliminary economic assessment.
Further, Shore Gold recently updated its resource estimate for the Star-Orion South project, in Saskatchewan, increasing the project’s indicated resource to more than 55-million carats, paving the way for a revised feasibility study and economic assessment.
North Arrow minerals also continued to advance work at its Pikoo project, in Saskatchewan, the newest diamond discovery in Canada. Since the discovery in 2013, at least four other companies had staked surrounding ground and were active in the same area.
In May, a company called Trigold, now Crystal Exploration, was in the process of acquiring the rights to a series of diamond-bearing kimberlites in Nunavut, including Muskox, which was a candidate to provide feed to the failed Jericho mine.
As diamond producers adjusted to a new reality of subdued demand, Zimnisky pointed out that diamonds could, once more, become a sought-after addition to major miners’ assets.
“Iron-ore, coal and copper prices have hit the major diversified miners hard over the last few years. Diamond prices, while still down, have out-performed on a relative basis. Last year, Anglo American’s overall earnings before interest and tax decreased 25% year-on-year, while De Beers’ equivalent earnings figure actually increased 40%. The De Beers unit represents 25% of Anglo’s total assets.
“If they aren’t already, I would expect the Rios and BHPs of the world to start actively looking at diamonds again as a way to diversify their portfolios,” Zimnisky stated.