Put A Ring On It - Why It Might Be Time To Invest In The Diamond Industry

October 9, 2017

Put A Ring On It – Why It Might Be Time To Invest In The Diamond Industry

  • Diamond producers expect a supply gap to form from 2019 onwards, which is a great fundamental indicator.
  • However, the current environment isn’t the best, and has made miners cheap. Many of them are down more than 30% this year.
  • I’ll discuss mining costs, risks and rewards, how to invest, and analyze I’ll two miners.




Introduction

A recent Bloomberg article described how diamond stocks have performed extremely badly in the last year.

Figure 1: Diamond stocks compared to other mining stocks. Source: Bloomberg.

The article identified the main reason for the drop was individual miner issues as gem prices haven’t fallen, and concludes by giving an oversold mark to the industry.

Apart from being an interesting field to research, the potential bargains really enticed me to look deeper into the industry. If the industry isn’t interesting to invest in, at least we should be able to determine whether or not it’s a good time to buy some diamonds for ourselves or significant others.

The Diamond Industry

The industry is dominated by two major players: De Beers, a subsidiary of Anglo American, and the Russian Alrosa PJSC, with other smaller miners also trying to play the field.

Figure 2: Global diamond production. Source: Alrosa.

When I read an article like the one form Bloomberg that describes how many miners had production issues, I really want to dig deeper to see if prices will go up due to lower supply which will lead to higher stock prices in the future.

What’s interesting about the industry is that demand is growing but supply is flat.

Figure 3: Global demand for diamonds has been growing at 4% per year. Source: Alrosa.

Most diamonds are sold in the U.S., but growth in demand is expected to come from other parts of the world as they develop and become richer.

Figure 4: Global demand from diamonds. Source: Dominion.

The growth in sales isn’t covered by production growth as supply growth is expected to be around 2% for the next two years, and then flat.

Figure 5: Global production growth. Source: Alrosa.

This is expected to lead toward a supply gap which should lead to higher diamond prices which is an excellent indicator for investing.

Figure 6: Diamond supply gap opening. Source: Alrosa.



How To Invest

When investing in a commodity or something similar, as in this case, the main thing to focus on is mining costs. Lower mining costs mean that the company is profitable at whatever diamond prices, but the upside is also lower because higher prices don’t increase the margins as much as they do with a barely profitable miner.

Figure 7: Diamond mining costs. Source: Alrosa.

Canadian companies have higher cash costs and thus should be better investments if diamond prices really shoot up. African miners have lower costs and are therefore more profitable at current prices.

As with other miners, successful investing in diamond companies is extremely dependent on the individual miners you purchase.

Companies that are about to commence production, like Firestone Diamonds, will be the risky ones but will also offer the highest potential. Established producers in stable jurisdictions, like Dominion Diamond in Canada, will be the expensive companies, while African miners like Lucara Diamonds will be the cheapest due to all of the risk perceptions the market has about operating a mine in Africa.

Is Now A Good Time To Buy Diamonds?

A supply gap coming means that there is a higher probability that we’ll have to pay more for diamonds or we’ll have to buy smaller ones. Neither option is very romantic, so consider buying a diamond prior to 2019 and prices are expected to increase.

It’s good to know that diamond prices aren’t so much affected by recessions and economic activity. In 2009, diamond prices suffered but quickly recovered to previous levels. Thus, even though they’re considered a luxury, there will always be demand for diamonds.

Figure 8: Diamond prices in the past. Source: Dominion.

Many of the diamond producers pay a nice dividend, so taking a position now will create some income and leave the upside open for when the supply gap opens.

Example – Two Diamond Miners

To give you a better understanding of what investing in diamond miners is all about, I’ll briefly discuss two stocks, Lucara and Dominion Diamonds.

The first thing to watch for is stock price volatility. I’ll start with Lucara.

Lucara Diamond Corp (TSX: LUC.TO)

It took Lucara more than a year to sell the biggest gem of the century, its 1,109 carat Lesedi La Rona.

Figure 9: Third ever largest diamond was just sold for $53 million. Source: Sotheby’s.

The slow sale resulted in the stock price dropping as $50 million is almost a quarter of yearly revenue coming form only one gem. Failure to deliver more stones like this one could put more pressure on the stock, while new ones could really make it skyrocket.

Figure 10: Lucara’s stock price dropped like a rock due to the slow sale. Source: Yahoo Finance.

With Lucara, it basically all depends on the next big stone but until that happens, and if you can handle the volatility, you can enjoy a diamond producer with a 4% dividend yield.



Dominion Diamond Corporation (NYSE: DDC)

Unlike Lucara, Dominion is a Canadian miner whose success purely depends on its projects.

Figure 11: Dominion’s projects. Source: Dominion.

If all goes as planned, the company is going to double sales and significantly increase net profits which should further push the stock price higher.

Figure 12: Dominion’s expected EBTIDA. Source: Dominion.

However, upside is expected from the market as Dominion’s stock price did the opposite of Lucara’s and has almost doubled in the last year.

Figure 13: Dominion’s stock price in the last 12 months. Source: Yahoo Finance.