Wall Street Confidential

Diamonds Are No Longer Forever

March 25,2009

    by Edward Jay Epstein

Responding to the global recession in 2009, De Beers’ once mighty diamond cartel shut down about half its global production. Earlier this year, it closed Orapa Number 1 in Botswana, the world’s biggest diamond mine, as well as smaller ones in South Africa, Namibia, and Canada, and, in April, ended its exploration operations in the mineral-rich Congo. The immediate
problem was a nearly 25 percent drop in prices in December. But De Beers’ fear is not just that retail prices will continue to decline - it has managed that problem before - but that the public will begin to sell its hoard of diamonds, or what is called at De Beers "the overhang."
At the heart of this concern is the reality that, except for those few stones that have been permanently lost, every diamond that has been found and cut into a gem since the beginning of time still exists today. This enormous inventory, which overhangs the market, is literally in - or on - the public's hands. Some hundred million women wear diamonds, while millions of other
people keep them in safe deposit boxes as family heirlooms.
De Beers executives estimate that the public holds more than 500 million carats of gem diamonds, which is more than 50 times the number of gem diamonds produced by the diamond cartel in any given year. The moment a significant portion of the public begins selling diamonds from this prodigious inventory, the cartel would be unable to sustain the price of diamonds, or maintain the illusion that they are such a rare stone that their value is, as the ad slogan claims, "forever."
As Harry Oppenheimer, who headed the cartel for more than a quarter of a century, pointed out, "wide fluctuations in price, which have, rightly or wrongly, been accepted as normal in the case
of most raw materials, would be destructive of public confidence in the case of a pure luxury such as gem diamonds, of which large stocks are held in the form of jewelry by the general public."
The genius of the cartel was creating this "confidence" in the myth that the value of diamonds was eternal. In developing a strategy for De Beers in 1952, the advertising agency N.W. Ayer
noted in a report to De Beers: "Diamonds do not wear out and are not consumed. New diamonds add to the existing supply in trade channels and in the possession of the public. In our opinion old diamonds are in 'safe hands' only when widely dispersed and held by individuals as cherished
possessions valued far above their market price."
In other words, for the diamond illusion to survive, the public must be psychologically inhibited from ever parting with their diamonds. The advertising agency's basic assignment was to make women value diamonds as permanent possessions, not for their actual worth on the market. It set
out to accomplish this task by attempting through subtly designed advertisements to foster a sentimental attachment to diamonds that would make it difficult for a woman to give them up.
Women were induced to think of diamonds as their "best friends." This conditioning could not be attained solely by magazine advertisements. The diamond-holding
public, which included individuals who inherited diamonds, had to remain convinced that the gems retained their monetary value. If they attempted to take advantage of changing prices, the
retail market would be chaotic.
Even during the Great Depression of the 1930s, there was only a limited overhang, since the mass-marketing of diamonds had begun only a single generation before the crash. So even though demand for diamonds almost completely abated, De Beers, by shuttering all its mines and
borrowing money to buy up the production of the small number of independent mines that still existed, was able to weather the crisis.
Today, however, with many generations of the diamonds it mass-marketed overhanging the market, and most of global diamond production in independent hands, it no longer is in a position to bring supply and demand into balance. Adding to this precarious situation, diamond
cutters, manufacturers and dealers, have, as of Feb. 15, an estimated $40 to $50 billion worth of
diamonds in mines in the pipeline that will intensify the downward spiral when the gems reach the market later this year.
If the current recession so deepens that the desperate need for money trumps the tenacious grip of sentiment, and the public begins selling even part of its hoard, it could finally shatter the brilliantly nurtured illusion that the value of the glittering stones kept on fingers, in jewel boxes,
and in vaults is eternal. As the overhang came pouring into the market, De Beer's nightmare could become a reality.