Rough Diamond Auctions-Do Rough Auctions Promote Price Volatility?

Nearly all mining companies hold diamond auctions. In fact, a single major diamond producer held 121 diamond auctions last year. There is an auction within a gap of two weeks or less.

Auction Boom
While auctions may have been initiated as an innovative measure to boost bottom lines and tide over the global downturn, many midstream players believe that numerous diamond auctions held by major producers today, spurs price uncertainty and volatility.

Informs Neil Ventura, Executive Vice President of Auction Sales for the De Beers Group of Companies; “De Beers sells 90 per cent by value of its available supply of rough diamonds to its Sightholders every five weeks or 10 times in a year. In addition, we have about 100 individual events each year, which are a combination of different auction types, such as spot auctions and fixed price forwards, for different types of diamonds such as grainers and smalls. Sightholder sales is an entirely different business unit from auction sales.”

These auction events include the recently phased out old forward contract sales on a floating price basis which is replaced with the Fixed Price Forward Contract sales, introduced as a pilot in February 2017.

“So De Beers will have 10 Fixed Price Forward Contract sales auction events each year in addition to spot sales that take place every two weeks and within the spot sales there are individual events for different types of goods, adding up to more than a 100 individual events. In 2016, we held a total of 121 spot and forward auctions.” explains Ventura.

Producers Promise SteadySupply
Other producers, like Rio Tinto and ALROSA too have various tendering and live auction events every year in addition to term contracts with a select group of diamantaires with whom they have supply commitments.

Patrick Coppens, General Manager, Sales and Marketing, Rio Tinto Diamonds elaborates, “Rio Tinto’s rough diamond productions is committed to long-term contracts with our Select Diamantaires, with about 20 per cent on average offered in five spot auctions per year called Rio Tinto Diamonds Invitation Sales.”

While Rio Tinto auctions its pink diamonds from Argyle each year, De Beers auctions 10 per cent of http://www.diamondworld.net/gfx/editContent.gifBotswana’s production though Okavango Diamond Company, while ALROSA

Evolution of Diamond Sales
Auctions are the new face of diamond sales and the obverse of the traditional Fixed Price Sight System. In between, trade and direct negotiations also help diamond sales. While all systems co-exist, auctions can singularly optimise profits for the producer and deliver value to participants in terms of meeting flexible supply demand. Rough diamonds are today sold by tender and live auctions with bidding in real time and won by the highest bidder at the closing time.

Tender Sales
Tender sales are silent auctions where participants submit bids for various lots of roughs. Tender sales give smaller players access to direct supplies of rough.

Spot Auctions
Rough diamonds are also sold through spot auctions. There is no reserve starting price. Participants bid while stating the quantity of goods they want to purchase. Goods are sold and delivered immediately. Spot auctions help to establish prices. Special spot Auctions help to sell larger stones.

Online auctions
In online auctions, participants from anywhere in the world can bid for rough diamonds. Goods are visible to all participants. Buyers can make multiple offers on a parcel and bid as high as they are willing to pay. Internet auctions were started by De Beers in January 2008.

Fixed Price Forward Contract Sales
Participants bid for future supply, currently up to three months, of the types and quantities of diamonds they require, at fixed prices. Successful bids can help secure longer-term supply, to enable more effective planning and commitment to longer term agreements with their own customers.

There are other types of auctions too, like the Japanese auctions where bidders must bid at each level to remain in the running for the featured item, and Dutch auctions where the auction begins with a high asking price which is lowered, until a participant is willing to accept the price.

At any of these auctions, it is mostly the small to medium sized manufacturing businesses that form the core of an auctions’ customer base. Auction participants need to meet a range of financial and ethical compliance requirements before being approved as accredited buyers. After all, auctions are a producers’ domain meant to test prices, which forms the basis for future sales, to keep prices unpredictable auctions larger diamonds, fancy colours and some stones that are polished in Russia.

Russel Shor a senior industry analyst with GIA explains “Major producers hold rough diamond auctions for only a small portion of their production, while most of the smaller producers tend to sell all of their goods by auctions. Others have a group of regular, vetted clients who count on a steady supply to keep their manufacturing operations running consistently.”

Price Discovery
Such term supply commitments promise diamond producers a steady and predictable source of cash flow. The reason only a small portion of diamonds are sold through auctions is because the primary purpose of auctions is not sales as much as price discovery, which influences prices at sight holder sales. States Shor, “Generally, most large producers employ a mixed system of set contract sales, like sights or cycles, and auction sales. The majority of producers believe that auctions offer the best gauge of current market prices and demand trends which often influence their pricing for their contract goods.”

Consider this, the actual sales price at auctions varies at each event, depending upon market perception and demand. So these prices are a good indicator of the market and helps producers set prices for lots allocated under term contracts. Thus auctions are used to find competitive prices of goods, which allow producers to maximise value and increase sales revenue. These events also ensure a steady supply of diamonds through the pipeline, the raw material for the industry. However, industry players believe that auctions impact diamond prices and may well be responsible for the flux in the market.

Price Volatility
Even the Global Diamond Industry 2016, prepared by the Antwerp World Diamond Centre, and Bain & Company states that volatile diamond prices and stagnant diamond jewellery sales during the past few years have continued to squeeze the profitability of midstream players. This is the segment which is highly sensitive to pricing volatility.

Explains Shor, “In volatile markets, auctions can impact diamond price movements. If demand and prices intensify for auction goods, that quickly finds its way into the general market. And, as we saw in the latter part of 2015, the reverse is true as well.”

BHP set an example for other producers who experienced similar success. Auctions became more sophisticated and moved into the internet space. Following the global economic crisis, De Beers went on to innovate and structure within the entire auctions space.

Confirms Ventura, “De Beers pioneered the use of online auctions to successfully sell rough diamonds back in 2008. Since then we have continued to innovate in this space, and enjoyed significant commercial success with this approach to sales. We have changed the long held industry practice of only selling every four to five weeks to selling on a spot basis every two weeks. This has been a great success with significant uptake from customers.”

Proliferation of Producers
The number of auctions increased even as the number of producers proliferated. In 2013, there were 27 active diamond mining companies operating 40 mines. “By 2014, as much as 30 per cent of all rough diamond production worldwide was being sold through tender and auction events,” informs Shor.

Today, auctions are an established source of rough supply. But industry players further down the pipeline are not pleased.

Finding True Value
Even when BHP Billiton set the trend, the International Diamond Manufacturers Association had criticised the company, complaining that “bidding was competitive in nature and would encourage speculative buying. Prices could become volatile, cutting into profits and discourage banks from financing rough purchases. The auctions system was especially hard on the small and medium sized companies that comprised the bulk of its membership.”

“But Billiton maintained that it needed to find the true market price of its goods to ensure that it did not underpriced its diamonds,”added Shor.

Ironically, an economic study by BHP also confirmed that the rough market remained volatile from mid-2009 through 2012, as average prices more than tripled.

Even today, the competitive bidding in auctions results in higher prices for producers from customers who are willing to pay the premium to get specific quality and quantities of rough.

Auctions for Better Relationships?
Diamond producers also encourage customers to participate in auctions by incentivising successful bids, which can open up better relationships for them with the producer.

Informs Ventura, “Purchases made at De Beers Auction Sales events contributes to customers potentially entering the company’s Global Sightholder Sales’ ITO and therefore represents an opportunity for customers to grow and develop their supply relationship with De Beers.”

Explains Ventura, “Our sales generate a wealth of demand and price data that acts as one of several inputs into pricing decisions taken by De Beers. Auction sales results, along with results from our much larger long term contract sales business, and a wealth of other demand and supply indicators inform production decisions.”

Reserve prices at auctions are also determined based on market demand and price indicators. Producers are reluctant to reveal the basis for pricing decisions.

“We use a proprietary algorithm developed in-house to determine reserve prices for the sale of our rough where these are applied,” states Ventura.

Rio Tinto is also not willing to elaborate. “Ultimately, the market determines the clearing price at auctions and participants will interpret these clearing prices on an individual basis.” Coppens comments.

Speculative Buying?

While the logistics for fixing reserve prices may be subjective, sophisticated and mostly secretive, there is a thumb rule. As Shor explains, “Diamond producers have a good idea of the rough market and where to set the reserves. Generally, they are at a slight discount to the prevailing market.”

Speculative buying from large companies could be adverse fallout of auctions when rough prices, based on results of auction sales, are being constantly adjusted, and mostly upward. However, with banks exercising caution, the market has been somewhat protected.

Explains Shor, “Most producers try to dampen speculative buying although it becomes difficult if everyone is speculating. Today, however, with the banks limiting credit facilities, speculative buying is much more difficult. Auctions have made diamond prices more volatile – at least on the rough side. The volatility has not translated fully to the polished side because there is usually an inventory overhang that acts as a strong buffer.”

While price volatility may not yet have percolated to the end customer, and there is more sale price visibility, it is moot that producers are using auctions to boost revenues while midstream players bear the brunt.