Wall Street Confidential.

The Russian Take Over Of The Diamond Cartel: Part II-- The Overhang


May 29,2009

    by Edward Jay Epstein

The ultimate threat to the new diamond cartel is that the public will begin to sell its hoard of diamonds, collapsing "the overhang." onto an already fragile market. The Russian monopoly which is now taking over from De Beers must confront 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. Despite the myth of rareness, some hundred million women in America alone wear diamonds, while millions of other people keep them in safe deposit boxes as family heirlooms. Indeed, it is estimated 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 diamond cartel, whether run by De Beers or Russia, 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 old 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 De Beers 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 billions of dollars worth of diamonds in the pipeline that stretched from the cutting factories in Israel, Belgium, and India to wholesalers in New York that are financed on bank credit. Unless market conditions improve, these diamonds will have to be dumped on the market. Further intensifying the downward spiral. Uncut diamond prices have fallen by more than 60 percent since mid-2008.
Even if Russia, the new overlord of the cartel, stockpiles all the diamonds that come out of its Siberian mines, as it is reported to be now doing, it still has deal with the terrifying prospect of the huge overhang crashing into the market. As a top adviser to the Russian Diamond monopoly recently told the New York Times, “We have to tell people that diamonds are valuable...We are trying to maintain the price, just as De Beers did, But what we are doing is selling an illusion.” But what as the current recession deepens, it cannot maintain the price in the way that De Beers so successfully did for over a century, and the brilliantly nurtured illusion that the value of the glittering stones kept on fingers, in jewel boxes, and in vaults is eternal? Without that illusion. overhang will come pouring into the market, and diamonds may become just another semi-precious trinket.