The investor’s best friend?

15 08 2010

Diamonds may be a girl’s best friend, but are the diamond producers suitable for serious investors? Summit TV speaks to James Allan from the Allan Hochreiter consultancy

DAVID WILLIAMS: Welcome to Face to Face, we’re talking about the diamond market with James Allan of Allan Hochreiter. James, the diamond trade is different to others – let’s talk first about supply and demand projected. My overall impression from what I have read is that demand is going to grow but supply is going to be pretty constant…

JAMES ALLAN: Demand has been growing pretty well in the last four or five years – it peaked around 8% in 2002 but slowed global demand probably growing at around 5% which is a fairly significant number of diamonds. If we think diamond production globally is around about $13billion a 5% growth rate is $650m worth of consumption every year that’s being added to the market. South Africa probably produces twice that so that gives an idea of the kind of growth rate in the world. In terms of supply one of the problems with diamonds is they come from kimberlites, and everybody says “I’ve got a kimberlite near Kimberley” and you say “whoopee, that’s why it’s called Kimberley.” Kimberlites are very common – there are about 6,500 of them in the world, and of those there are probably 20 producing mines. From the statistics the geologists will tell you that maybe one in 100 kimberlites contains microdiamonds, and one in 100 of those may become profitable – so finding a producing kimberlite, or a kimberlite with the potential to produce is extremely difficult. It’s extremely costly – estimates have ranged from $500million to $700million to find a kimberlite that has the potential to become a mine. So it’s extremely difficult to find new mines – you will see the most recent ones have been in Canada. In South Africa the most recent one was Venetia 25 years ago. The supply side is looking reasonably good at the moment in terms of some growth, but it’s probably growing at 1% per annum – so demand is growing at 4% to 5% per annum, supply is growing at 1% per annum and you have an imbalance in the market.

DAVID WILLIAMS: The industry has been revolutionised over the last few years. De Beers changed their approach, the stockpiling stopped – there’s much more supply and demand the real market operating – but is South Africa closer to the gold industry? The gold mines were discovered early but they’re largely mined out. One thinks of De Beers’ aerial prospecting over huge areas of land that saves a lot of money – where do we stand in terms of future prospects in South Africa?

JAMES ALLAN: I think everybody keeps going over the same ground in South Africa hoping that new technology will reveal something that hasn’t been found before. The reality is that some of the big mines in South Africa are getting towards the end of their lives – we’ve seen De Beers sell Cullinan for instance to a smaller player Petra Diamonds. They will probably make a great success of it as they have done with Koffiefontein. Finch Mine is coming to the end of its Block 4 – they have then got to think about do they go underground to the next level which is Block 5? They will face the same dilemma that they did with Cullinan. Venetia has to go underground in 2020 – they start drilling next year to delineate the ore body at depth, so there’s a massive plan in place there – but at this stage there are no new big kimberlites to be found in South Africa, or so we think.

DAVID WILLIAMS: Reading a report by Tessa Kruger which quotes analyst Des Kilalea they identify the top 10 investable diamond companies by market cap – it’s interesting only one of them is South African, and that’s Trans Hex – but you say Rockwell has now overtaken them. We spoke to Rockwell a couple of weeks ago when they listed…

JAMES ALLAN: I must note here that I am corporate advisor to Rockwell – and was involved in the listing and the capital raising process – so I’m obviously a little bit biased in that direction. Rockwell’s market capitalisation is around about the same as Trans Hex, possibly slightly larger on any given day. It’s listed in Toronto as well as in South Africa so one needs to take a look at that – the fact that there are shares listed in that country as well. So that will make two companies listed in South Africa in the top 10.

DAVID WILLIAMS: Looking at the sector there’s lots of little companies doing things – consolidation ahead which means different opportunities for investors?

JAMES ALLAN: Absolutely. I think there’s probably 30 companies in what we would call the mid-tier market capitalisation globally that are involved in diamonds. Some of those are producers – very few of them I’m afraid – some of them are explorers, and most of them have got a great deal of blue sky. There will be consolidation in that industry as we go forward…

DAVID WILLIAMS: What about pricing? Other commodities have run very hard in the last few years – some of them are obvious, China needs iron ore – how do diamonds compare in terms of price?

JAMES ALLAN: We have seen iron ore go up by 30% and 40% in recent price increases, we’ve seen copper prices double and treble over the last five years and similar things with all the industrial metals – what we have got to realise is that the Chinese economy is at the stage where it’s consuming industrial metals, and that’s been really driving the commodities market. Where diamonds are concerned the Chinese are consuming more and more diamonds – growth there is in the double digit area – but China is probably only consuming about 3% of the world’s diamonds at this stage, so it will be some time before China has the same kind of impact on the diamond market as it has on the other commodities. None the less diamond prices if we talk about on a global average are probably 35% to 40% up on where they were in 2002. You must remember of course that historically the diamond market was a more managed market, and you certainly didn’t see the volatility in diamond prices that you had in the other metals – so it was coming off a higher base.

DAVID WILLIAMS: The desirability of diamonds – it’s a unique commodity that depends on what people think, they don’t need it to do things – is there any chance the market could fail because desirability leaves?

JAMES ALLAN: We could debate whether people need diamonds or not. I would just point to the fact that while I was waiting for you I pulled the plastic model diamond out that John Bristow showed you on the show a couple of weeks ago – immediately all the women working on their computers clustered around to look at this piece of plastic they thought was a diamond. Women love diamonds, men love women – I think as long as that carries on we’ve got a diamond market.

DAVID WILLIAMS: That enduring phrase springs to mind “diamonds are a girl’s best friend.”

JAMES ALLAN: An absolutely phenomenal phrase.

DAVID WILLIAMS: The best friend of investors in the next couple of years?

JAMES ALLAN: I think that it will be a very good friend of investors – remember it’s got to compete against all the other asset classes. We’ve seen massive increases in stock prices for many of the other commodities – diamond shares have underperformed relative to the others – so a lot of investors are saying this is the next sector that’s going to perform over the next five years. Let’s not forget that we are looking at a growing deficit in diamonds – growing over the next five years to maybe an $8billion rough diamond market in a total market of $13billion – so very good demand could come through for some of the shares, particularly those that are producing diamonds. I think this is going to be the key thing investors are going to look for is delivery – it’s all very well having blue sky and having lots of what the Canadians call “moose pasture” that we might call “gorilla pasture” if you’re in the DRC or “sheep grazing” in the Northern Cape – but more and more investors are going to say where is the delivery from the company?

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15 08 2010
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