The rough diamond market is facing the worst trading conditions in more than twenty years and no material improvement in underlying market conditions is expected until the second half of 2009.RBC Capital analyst Des Kilalea said demand for rough diamonds was depressed at the start of the year similar to the end of 2008. With little pull-through from the retail market, demand to replenish the pipeline with polished is very weak. Antwerp, Tel Aviv, India and other cutting centres have had their slowest January in at least 20 years and few are predicting activity picking up before the second half of the year, he said.Kilalea said De Beers' first rough diamond sight of the year was evidence of the level of demand in cutting centres as its January sight - a sale to selected customers - was estimated at between $80m-$150m. According to RBC's records this was the lowest first sight De Beers had in 25 years.The January sight is normally about 8%-12% of the year's total and sets the tone for the busier six months. It is also a reflection of the pace of Christmas sales as it highlights the cutting centres' expectations of the pace of converting receivables into cash.The retail sector also experienced slow Christmas sales with Tiffany & Co's global sales down more than 20% and the company saying it was the most challenging trading period in its 21-year history as a public company.The company said two-thirds of the decline in sales was driven by a decrease in the number of transactions and the balance from people buying lower-priced goods.The analyst said poor trading in the retail jewellery sector amounted to less cash flowing back to cutters and polishers of diamonds as receivables take longer to convert to cash. This in turn affected their ability to repay bank debt and fund new rough or polished diamond purchases.Consequently demand for rough and polished diamonds will probably remain depressed at least until the second half of the year and the level of bank indebtedness in cutting centres is unlikely to decline materially, he said.The analyst added that given a major scaling back of cutting centre activity, particularly in India, it was increasingly likely that banks could see a significant rise in bad debts.Production Cutbacks
The majority of diamond producers have put plans in place over the last three months to reduce production. Global production could fall from 160m carats to 120m in 2009 as major producers De Beers, Alrosa and Rio Tinto limit production to meet lower demand. De Beers has started a brutal production cutback programme, which could see its production decrease by more than 30% over the year, said Kilalea.He said the production cuts would make a positive impact, but until liquidity improved and final demand started recovering, diamond prices would not see a material boost.However, when consumer confidence returned the shortage of rough diamonds could be magnified as a result of the production cutbacks.The analyst said the outlook for rough diamond demand remained depressed and could deteriorate further. The next two quarters are likely to see an acceleration in unemployment rates that will have an impact on consumer spending, particularly in consumer durables and luxury goods.While rough diamond prices have already fallen 30-50%, lack of demand could result in further weaknesses given a lack of liquidity in cutting centres and very slow sales in the final retail market.Until we see the trough in the market, particularly in the United States, the prospect for an improvement in sales remains cloudy.The analyst commented that it was hard to find investment merit in the diamond sector. With prices and production falling, the priority is cash conservation.Potential corporate action is likely to be the only ‘spur' to share price performance in the next two quarters, and even here the pace of activity will be slow.