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Price bubbles persist on the expectation that greater fools will come along. That’s why price manipulators find it profitable to start bubbles. However, bubbles inevitably burst when the supply of fools runs out. Over the last few years, De Beers the owners of the Central Selling Organization, which runs the diamond cartel kept on buying as the Russians unloaded just about their entire diamond hoard. No-one knows whether the Russians, desperate to turn domestic assets into foreign cash, sold off their huge holding out of plain dumb luck, or if their massive sales rested on inside information about new mines or diamond-synthesis technologies. Either way, De Beers clearly bet big on future diamond prices. But current technological trends make it very likely viewed from the near future that the Russians pulled off a major financial coup and that De Beers committed a major blunder. De Beers blundered by greatly overpaying for what are, in essence, just tiny lumps of carbon. Admittedly, diamonds are unusual lumps of carbon and until now even small ones have been found very rarely in nature. However, geologists have begun to learn that diamond is much more common in nature than they ever suspected. Furthermore, materials scientists are beginning to explain that much wider prevalence as they discover ways of synthesizing diamond without the high temperatures and pressures previously thought necessary. With this new understanding of how diamonds are created, geologists could find a lot more natural sources. But this prospect isn’t the principal threat to De Beers’ high-priced bet. The real danger is that scientists are rapidly improving processes that will turn cheap carbon into diamond by the ton. A diamond may still be for ever, but soon it will be for everywhere as well. In 50 years, when the diamond industry is making transparent kitchen worktops and wall-size video monitors, you won’t expect a couple to pay a thousand dollars for a fine 0.75 carat diamond ring any more than you expect them to pay a hundred dollars for an aluminium wedding ring today. De Beers will try to salvage its position by spending $200 million a year on persuading lovers and investors that a diamond is a girl’s best friend. The synthesis of diamond by the ton probably won’t start for several years, so consumers may go on believing this to be true. Consumers might keep diamond mines operating profitably until they see 50mm diamond lenses in a pair of $60 binoculars. But if De Beers still has a chance to liquidate its mountain of Russian gems, it has nevertheless already abandoned its traditional price support for so-called Indian goods consumer-oriented smaller stones like those common in the Argyle mines of De Beers’ former Australian associates. That’s a major pullback, since consumers have long been De Beer’s mainstay, paying far more at retail for their diamond chips than they could ever hope to recover from jewellers or pawnbrokers if they resold. Fortunately for their peace of mind, consumers typically live in ignorance of this, since most are buy-and-hold investors. Collector’s item By abandoning the Indian goods market, De Beers is taking the future value of its own diamond hoard out of the hands of those reliable consumers and placing it squarely with wealthy collectors. De Beers is betting that they will be as reliably foolish about those luxury goods as consumers have been about Indian goods. De Beers may be giving up any chance of liquidating its mountain of Russian gems at a profit. Collectors won’t wait until they start seeing diamond lenses in binoculars. Collectors differ from consumers in that they buy diamonds for the returns a portable store of value backed by De Beers’ promise of perpetual capital gains. De Beers has to reassure them that prices will keep rising. It’s currently trying to sell the line about rising demand worldwide, that growing Asian populations can barely wait for their incomes to rise enough to buy large diamonds. Rustum Roy of Pennsylvania State University, dean of the world’s diamond synthesizers, reckons that over the next 50 years diamond synthesis will almost certainly repeat the history of aluminium production from precious commodity to ubiquitous and economical engineering material. Diamond is a top engineering material in terms of its hardness, transparency, refractivity, thermal and electrical conductivity, electronic emission and many other properties that will generate demand for industrial quantities. The biggest demand will probably be electronic diamond semiconductor chips will bypass the thermal conductivity limitations of silicon, allowing yet more miniaturization. Some demand will still persist for diamond jewellery but it will be a mere fraction of overall diamond production. If diamond will be cheap and ubiquitous 50 years hence, that implies cheap diamond in 49 years. Cheap diamond in 49 years must then imply cheap diamond in 48 years and so on. According to what economists call backwards induction, cheap diamond in 2046 implies cheap diamond in 1996. Unless diamond-synthesis stops in its tracks, the price that collectors enjoy today should be the best they’ll ever see. Diamond gems will lose their connotations of wealth and privilege, and diamond mines will become expensive holes in the ground. Natural-resource cartels have often succeeded for years, even if they inevitably lose because their high-price policy invites technological innovation and substitution. But no process or product is inviolable for ever. Bolivian tin miners and Opec oil producers held out for years before they were bypassed. Natural resource markets, like all markets, can occasionally sustain price bubbles for a good long while. Today’s diamond price stability makes it harder for analysts to perceive the price bubble growing as diamond synthesis costs fall relative to slowly rising luxury goods prices or slowly falling Indian goods prices. De Beers can take some heart from experimental markets, which indicate that bubbles with stable prices over falling values last much longer than bubbles with upward spikes over falling or even stable values. Today’s slowly rising diamond price seems so normal and unobjectionable that markets have failed to react to the advance in diamond synthesis. Roy’s Penn State diamond-synthesis team was recently able to draw the first single large diamond crystal from a boule. With persistence they should be able to increase crystal size and lower costs incrementally. In another advance led by Pravin Mistry, Detroit’s QQC Corporation’s tool-coating team made a breakthrough when a technician accidentally substituted carbon dioxide for nitrogen in a coating process, instantly increasing the best diamond film deposition rate by a factor of a thousand. Spotting the sell-off Future economic historians will wonder why these developments failed to trigger a run on diamond gem prices. Bubble theorists will simply note that securities analysts and diamond dealers continued, irrationally, to concentrate on new diamond-mining prospects in Canada and depleting mines in Australia, while ignoring the prospect of industrial-scale production. But sooner or later the crash will come. The new perception will probably prompt most collectors, not just a few, to try to dump their hoards. If that happens, prices will collapse immediately. However, even if most collectors were to remain irrationally passive at the prospect of a price fall, the crash would still come. That’s because most diamond miners, dealers, cutters and retailers depend on external debt financing for their inventories and operations. In the face of a potential price crash, risk managers in banks with a major exposure to the diamond industry, such as ABN Amro, would insist on raising the premium for financing risky diamond inventories. As financing costs skyrocketed, dealers and cutters would trim inventories, and the resulting sales would trigger a price fall that would scare many collectors into selling. Don’t cry for De Beers, however. It has diamond-synthesis technologies among its assets and, even if the bubble bursts some day soon, it can hope to get out wholesale by touting those assets in the bubble that will inevitably accompany the rise of the new industry. One day the run will start, and if you have any diamonds today, the fact that you are reading this article increases the likelihood that you too will short diamonds. It may be hard to short the underlying, but publicly held diamond companies aren’t so hard to short. From there the battle between diamond bulls and bears will spread to dealers, cutters and retailers. If skyrocketing financing costs don’t put them out of business, collapsing stock prices will. Mark White is at financial consultants White & Associates in Mexico City |
