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THE FUTURE OF DIAMOND PRICES

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In my last blog post, I discussed how, contrary to popular myth, diamond prices do not always increase. In 2014 and 2015, diamond prices were down.  But what does the future hold for diamond prices.

There was an article in Rapaport magazine last November which addressed this issue. It reported on the expectation of DeBeers’ executives that the annual supply of rough diamonds mined is about to peak and plateau at around 160 million carats.  By 2030, they expect the annual supply of rough diamonds mined to decrease to around 115 million carats.

There is some finite supply of diamonds in the world. In 150 years of exploration, only 60 commercial mines have been discovered and only 7 of those are major producers.  As the end of the commercial life of the existing mines appears on the horizon, diamond mining companies’ have resorted to exploring all over the world, often in extremely remote locations with brutal climates (i.e. northern Canada and Siberia) and “challenging natural obstacles” to overcome in unearthing diamonds.

The costs of exploring and mining in these new locations is significant.  One DeBeers’ executive even suggested that, “maybe all the diamond mines have already been discovered.”

Add to this scenario,the emerging markets in India and China caused by their increasing prosperity and growing middle classes. This will add significantly in the future to the demand side of the equation.

So, we have an utltimately limited and annually declining supply of rough diamonds that is increasingly expensive to find and extract. This will be combined with growing populations of people who believe they can afford and who will increase demand for diamonds. If this future of limited and declining supply combined with increased demand materializes, diamond prices will increase in the foreseeable future.

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DIAMOND PRICES

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Many of my customers think that diamond prices always increase.  And for much of the history of the diamond industry, that was pretty much true.  When I first started in this industry in 1992, Debeers controlled about 80% of all the rough diamonds coming into the market.  For decades,it was Debeers company policy to manage the supply of diamonds to the trade, increasing it sometimes and withholding at others, in order to maintain stable and modestly growing diamond prices.  The reason the Hull Loan System accepts only diamonds as collateral on loans is that, historically, diamond prices have been very stable, which is what you want in collateral: stable value.

But now, the three largest diamond mining companies, Debeers, Alrosa and Rio Tinto together only account for about 60% of the rough coming into the market.  There are more players and more competition.  In many ways, 2014 was a very different year for the industry.  Demand slowed, especially in China (a big emerging market) resulting in increased competition among manufacturers to sell their inventory and declining prices as a result of that competition.  At the same time, the diamond banks tightened credit terms to the diamond manufacturers, insisting on greater financial transparency and less casual accounting practices from them, and refusing to finance 100% of their rough purchases as they have in the past.

As a result, Rapaport magazine reported that polished diamond prices fell for the 3rd consecutive year. The RapNet Diamond Index for a laboratory graded 1 carat diamond fell 8.7% in 2014; prices for a 3 carat fell 6.6%.  Smaller diamond prices declined too: 0.30 carat by 6.5%.

While the 1st quarter of 2015 was better, the decline resumed in the 2nd quarter as reported by Rapaport: “RAPI (price index) for 1 carat diamonds fell 1.6% during the second quarter of 2015 and was down 15.3 percent from a year earlier.”

This discussion relates entirely to interdealer markets: where wholesalers and retailers buy from manufacturers, not to retail prices. But it is these markets, the prices that retailers, especially, have to pay to acquire inventory that determines loan value.

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How Cut Affects Loan Value

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People sometimes use the terms cut and shape synonymously.  But cut means more than shape and the Rapaport Price List has different price matrices for round and fancy shape diamonds.  The Price List is actually for well cut diamonds.  That has a more exact meaning in the case of round diamonds than it does for fancy shapes.

A really well cut round diamond has a table (top facet) that is between 55% and 59% of the stone’s diameter, a depth that is about 59-60%, star facets that are greater than 50% of the length from table to stone edge and lower girdle facets that are 80% or more of the length from the girdle to the culet.  It will also have very good symmetry and polish meaning that the facets will be similarly shaped, not misshapen and be free of scratches, nicks, abrasions, etc.  The Rapaport Price List is meant to be a starting point for negotiations between dealers for diamonds with actually somewhat more lenient standards than these.

While the cut of a diamond may be the most important factor in determining the optics of a diamond; how much brilliance, scintillation and dispersion the stone shows, it has the least effect on loan value. That is because there can be jumps or declines of hundreds of dollars per carat as you move from one clarity or color grade to another on the price list. And, since I am appraising most collateral in the mounting, it can be easy to be off by a grade on the color or clarity.  The mounting limits your view, hides inclusions and masks color.  So I rarely assign a premium to a well cut diamond since the Price List is for well cut diamonds anyway.

I have taken in as collateral many diamonds over the years that were cut in the 1950s, 60s and 70s that are deep and have large tables.  These were cut at a time when manufacturers were more concerned about cutting the largest diamond from the rough rather than the best. If the optics are reasonably good, I usually do not downgrade the loan value because there will be buyers for the stone.  If the optics are poor I will discount the loan value and I have even refused to accept as collateral stones that simply do not have the optical effects that we look for in diamonds and think of as beautiful.

Old European cut diamonds can be beautiful but they are an excuse the dealers use to offer 75% of what they would for a modern round brilliant cut diamond. And so their loan value reflects that market reality. Good cut in fancy shapes is somewhat harder to define but is affected by the length to width ratio of the stone, its depth and the attractiveness of the curves.

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THE ORLOFF DIAMOND

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This is another piece on the world’s famous and historic diamonds, although not reprinted from Rapaport magazine, as the blog on the Hope Diamond was.  This information comes from the GIA course materials that I happened across when looking up a diagram that I wanted to use for a facebook post.

The Orloff, like so many of the world’s oldest and most famous diamonds traces it origins to India. In the 1700s, it was (so the tradition goes) one of a pair of diamonds that served as the eyes of an idol in one of southern India’s holiest shrines in the city of Srirangam.

It was stolen by a French adventurer – France and England were then battling for control of India and its wealth. He took the diamond to Madras and sold it to an English sea captain for 2000 pounds sterling. It then changed hands several times ending up in Amsterdam where it was shown to the Russian count Gregory Orloff.

“Orloff was an ex-lover of Empress Catherine the Great. Hoping to regain her favor, the count bought the diamond for 90,000 pounds (some people clearly made a lot of money) and took it back to Russia. In 1774, he gave Catherine the tremendous gem, which has ever since been called the Orloff. Catherine accepted the gift and had it mounted in the Imperial Sceptre. In return, she gave Orloff a marble palace, but saved her sexual and political favors for others.  In 1783, the count died, insane.”

When Napoleon’s Grand Army was about to enter Moscow in 1812, the Russians hid the diamond in a priest’s tomb. Napoleon discovered the gem’s location and was about to claim it as one of the spoils of war, when, according to legend, the priest’s ghost appeared and pronounced a terrible curse on the desecrators.  Napoleon fled in fear without the diamond.

Today, the 189.60 carat Orloff remains where Catherine the Great placed it, atop the Imperial Sceptre.

 

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GIA, RAPAPORT & EGL

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The Rapaport Group banned certificates from the European Gemological Laboratory (EGL) on its RapNet trading network (an interdealer online market) several months ago.  The purported reason for doing so was the supposed widespread, consistent overgrading of diamonds by EGL.

Now it is important to understand that EGL USA is not the same company as EGL International or EGL Israel.  It is widely believed within the diamond industry that EGL overgrades on clarity but also to some extent on color.  By overgrades, I mean that they will issue a report with a clarity grade of VS2 or maybe SI1 on a diamond that would be graded SI2 by the Gemological Institute of America (GIA).

Martin Rapaport rather huffily condemned EGL for not grading to GIA standards in his letter, published in the Rapaport magazine, explaining why EGL certs were being banned from Rapnet. This might be a tad disingenuous from a man who publishes prices for the SI3 clarity grade, which, of course, is not recongnized by the GIA.  He is not immune from the charge that he is part of the overgrading problem if we are to believe that GIA standards must be maintained.

EGL Israel is especially egregious in the overgrading of clarity. EGL USA is less so.  In my experience, I have seen EGL USA reports in which the diamond is graded exactly as it would be at GIA.  But there is truth to the conventional wisdom in the industry that the grading standards at EGL are more lax than at GIA.  All of the dealers know that if they buy a borderline stone and want the best price for it when they sell, they get the lab report from EGL.  And it is not just dealers.  I have had many educated retail customers who decline interest in diamonds (sometimes very beautiful ones) if the lab report is from EGL.

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WHAT IS A CERTIFIED DIAMOND?

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Most people have heard a diamond described as “certified”. What does it mean to say that a diamond has been certified. Do only the best diamonds get certified? Surely a certified diamond must be better than a diamond that is not certified, right?

No, not necessarily.  What it means to say that a diamond is certified is that the stone has been sent to a gemological laboratory to be graded. If the diamond comes back from the lab graded I3 on the clarity scale and “P” on the color scale, it will be a certified diamond, but it will be junk. It will have little to none of the optical characteristics that we normally look for in a diamond and think of as beautiful.  It will be a highly included, yellowish stone with little brilliance, fire or scintillation.

But it will have a lab report.  All certified diamonds have lab reports (certificates) that give the buyer an independent third party verification that the stone is a natural diamond, that it has the dimensions, carat weight, color  and clarity stated on the “cert”.  The existence of the lab report means that the consumer does not have to trust what the sales person says about the size or quality of the diamond. But it does not necessarily mean that it is a good diamond.

So the next time you hear that advertisement on TV from the discount jeweler about 3.00 carat GIA certified diamonds on sale for $1.50, you will know that it probably is certified, but you will understand what that diamond must look like.

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FAMOUS & HISTORIC DIAMONDS

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I am going to reprint some short pieces out of Rapaport Magazine on some of the world’s oldest, most famous and historic diamonds.  In Europe, these were historically owned by royalty.  More recently, in the United States, fabulous and famous diamonds have been owned by Hollywood types or captains of Industry.

The Hope Diamond
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MORE ON CLARITY GRADES

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There is no SI3 clarity grade in the clarity grading scale of the Gemological Institute of America (GIA).  The GIA lab does not issue lab reports with an SI3 clarity grade.  But the Rapaport Diamond Report, which is the most widely used price sheet in the industry publishes prices for an SI3 clarity grade and the European Gemological Laboratory (EGL USA) issues lab reports with an SI3 grade.

Rapaport and EGL USA did this as a way of recognizing the distinctions New York dealers were making in their trading between eye clean I1 clarity diamonds and I1 diamonds that were not eye clean.  Better, or eye clean I1 stones were simply worth more money than I1 diamonds that were not eye clean.  Thus, a new clarity was born from the distinctions that traders made among I1 stones. First Rapaport and then EGL USA recognized those distinctions. GIA never has.

The problem for calculating loan value is that we always want to loan as much as we can and so we are tempted to use the SI3 clarity grade.  But if we have to sell the diamond, the dealers will want a GIA lab report (EGL is in disrepute) and most SI3 stones will get an I1 grade from GIA.  The 1.50 carat round diamond we have been using as an example is worth $900 less as an I1 than an SI3 and we would be unable to recover what we have loaned out.

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Total Carat Weight

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One other thing before moving to color and clarity:

Total carat weight is not the same as carat weight when it comes to loan value. Jewelers always have pieces with a relatively small center diamond such as a third of a carat and with lots of small side diamonds. The total carat weight of the piece may be a 1.00 or even 1.50 carat or more. The small side diamonds usually have no loan value at all. It costs more to set them than to buy them. So the loan value of the piece will be the loan value of the 0.33 carat (e.g.) center diamond, which could be as little as $150. The customer may have paid $2000 to $3000 for the piece and thinks they have a 1.50 carat diamond ring that should be very valuable as collateral on a loan. But having all the carat weight in a single stone is what maximizes the loan value of the piece of jewelry.

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How Clarity Affects Loan Value

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Clarity is a complex and problematic issue when it comes to defining loan value and I will write at least 2 blog posts on it.  Much of the difficulty lies with the SI3 clarity grade but I will deal with that next time.

For now, let’s go back again to the 1.50 carat round diamond I have been using as an example.  It was an SI1 clarity, G color diamond and had a loan value of $5700.  A 2 grade increase in the clarity grade to VS1 raises the loan value to $6840, an increase of $1140.  A 2 grade decrease in the clarity grade to SI3 decreases loan value to $3840, a decrease of $1860.  Another one grade drop to an I1 clarity grade further decreases loan value to $2940, a $900 decrease from the SI3 loan value and a $2760 decrease from the SI1 loan value.

You can see how important it is to get the clarity grade correct.  There are big jumps and drops in loan value.  And it can be difficult to get the grade correct because I am grading the stone in the mounting the vast majority of the time and diamonds are often set to hide the stone’s inclusions. If I call  it an SI1 and there are inclusions under a prong that make it an SI3, I will have more loaned out on the diamond than the dealers will pay if the customer abandons the loan and I need to sell it

This is part of the risk in my business and the pressure on me when doing the appraisal is always to call it the highest grade I can in order to both lend the most (I earn more then) and to be a financial solution to my potential new customer.  If I let that pressure induce me to make a wrong call, I will then have hundreds or even thousands of dollars too much invested in the diamond.