In this interview with diamond expert Paul Zimnisky, we take a look at the diamond market and the opportunities available to resource investors. Paul is well-known for his work as an independent analyst and consultant in the diamond and mining industry. He is a Chartered Financial Analyst and has worked in the capital markets industry for over 10 years. Paul is a contributor to many industry leading trade journals and websites and is a regular speaker on diamonds at numerous conferences around the world. And he’s the host of the recently-launch podcast entitled “Paul Zimnisky Diamond Analytics”.
Bill: Alright, let’s jump right into it. So what is your background and how did you come to focus on diamonds?
Paul: So my background’s as a buy side equity analyst. I started my career working for a family office in New York, I worked on their natural resource portfolio. And regarding diamonds, I guess I’ve just always been intrigued by the industry, it has a very rich history and it’s kind of perceived as mysterious which I think makes it interesting. And then you know, if you look from an investment standpoint, it’s a relatively under-followed industry, for reasonable reasons. But I think when you have a situation like that it always creates an opportunity that perhaps does not exist with the space that’s more closely followed, like gold or copper. So I always kind of, you know, I kind of like niche spaces for that reason.
Bill: When we look at diamonds, how are the price of diamonds determined, and you mentioned gold and copper. How is it different than how gold and copper, the price per ounce or the price per pound is determined?
Paul: So it’s end consumer demand is what’s ultimately going to drive the prices and of course supply. However historically De Beers has strategically managed global supply which would allow it to support prices. So a lot of people think diamond prices are artificially driven, but De Beers liquidated their stock pile between 2000 and 2004, and diamond prices made an all time high in 2011 almost a decade after the De Beers monopoly was dismantled.
So I think you know, one of the biggest effects of the De Beer stockpile was lower volatility in prices, but not necessarily higher prices. I think that the biggest impact that De Beers had on diamond prices was the demand that it drove through one of the most successful marketing campaigns of all time. You know, now all of that said, between De Beers and the Russians, they currently produce two-thirds of global diamond supply, and they have a contract sales mechanism. So in that sense, they’re managing prices but when they set their prices they take into account the tender market and they pay close attention to supply/demand fundamentals.
But when conditions do get really bad, they will hold supply from market, and we last saw this in 2015 when the Chinese economy slowed and that hurt global diamond demand. But the leaders, you look at De Beers and the Russians and Rio Tinto and Dominion Diamond would be in that category as well, they don’t necessarily predict prices for the independents, as you think would be the case. And I think this is substantiated by the fact that quite a few of the independent diamond miners are under considerable stress at the moment, because diamond prices have been relatively weak over the last five years.
Bill: So as I walk through Home Depot and I’m going through the tool section, I can see that there’s some saw blades that are diamond-tipped. So obviously there’s industrial demand there. What’s the breakdown between industrial demand and jewelry demand in the diamond market?
Paul: Yeah, so when we look at you know, diamond mining as an industry, almost all of the demand for that product is driven by the jewelry industry. When you look from a volume standpoint, I would say most of diamonds that are produced when you look naturally and synthetically are industrial-grade quality diamonds, but … I’ll try to give you some context here, so natural diamond production will say be approximately 150 million carats this year, but there’ll be 12 billion carats of synthetic diamonds produced for industrial application. So to answer the question, the synthetic basically cater to almost all of the industrial demand, I’d say probably 99%. And that’s produced in factories in China, and then from the natural diamond mining standpoint, almost all of the demand for that product is driven by the higher value, higher quality stones that make the economics work for a diamond mine.
I would just look at the industrial, the diamonds that are sold for industrial purposes from a diamond mine, it’s strictly a byproduct, there’s no mine that are economic with lower quality industrial production, it’s almost all driven by the jewelry market.
Bill: Are the synthetic, the lab-made diamonds, are they as strong as the ones that we mine out of the Earth?
Paul: Yes, it’s chemically diamond. So it’s the same from that standpoint. And I think when you look at diamond, you know, based on the quality of the diamond, it’s gonna determine the strength of the diamond, whether it’s you know, worn as jewelry or used for industrial purposes, but the diamonds that are synthetically made are still chemically diamond.
Bill: On the jewelry front, do they look the same, would the average person be able to tell the difference?
Paul: Yeah, it looks with the naked eye, you cannot distinguish. You need special equipment to distinguish between the two. But I think the important takeaway is that you can differentiate between a natural and a synthetic diamond with certainty, but you do need special equipment, which is becoming more widely available.
Bill: In the gold space, people have speculated that one thing that would destroy gold mining would be if somehow we’re able to chemically create gold in a lab. Therefore we have this abundance of supply, the price would go down, we wouldn’t need gold mining anymore. On the synthetic front with diamonds, could something like that occur?
Paul: Yes, that’s kind of interesting you bring up gold, so you actually can synthetically produce gold, but you need a particle collider and a lot of energy, so it’s nowhere near economic so, I don’t think the gold miners have to worry about that anytime soon. However, we’re definitely starting to see the proliferation of lab-created diamonds, that the cost to produce them has come down substantially. It still represents I’d say less than 5% of the market, but I think its potential to grow significantly, I think the question becomes is it gonna cannibalize the natural diamonds or is it more gonna be preceded by you know, consumers as a fashion jewelry product that’s not gonna necessary directly compete with a natural diamond will be considered fine jewelry.
So we’re kind of in this transition phase where the product is becoming available to consumers, the price is a little bit lower. But it’s not low enough where it would be put in the fashion jewelry category, so it’s kind of unclear how it’s gonna play out right now, but I think it’s gonna ultimately come down to how the product is marketed, and now just how the lab-created diamond is marketed but how the natural diamond industry continues to market their product. And I think going forward, I think the price of lab created diamonds will continue to come down substantially. And I think that differentiation in price is going to differentiate the lab created diamond into a fashion jewelry product. So I think it’s gonna have … It’s gonna compete less with natural diamonds as the price gets really, really low.
Bill: Do you buy a synthetic diamond at a 50% discount to an actual diamond? What percentage on average do you see the lab-created diamonds being sold for?
Paul: Yeah, so it’s moving very quickly. I would say five years ago, lab created diamonds were maybe 10% cheaper than an equivalent natural, and now it’s up to 60, 70% cheaper.
Bill: That’s significant.
Paul: Yeah, at a wholesale level they’re like 85% cheaper. So it’s moving very, very rapidly. There’s a lot of money being invested in lab-created diamond production technology, and it’s resulting in higher yields and better output at cheaper prices. So I think that trend will continue, and I think that’s ultimately what’s gonna differentiate the two products is the price. And then in the background you kind of have all the industry participants are understanding the application of this, and I think they’re doing everything they can to try to start differentiating the product using marketing and making sure this detection technology that you could use to distinguish between the two is readily available and affordable so every industry participant can have it.
But there’s certainly concern that it’s gonna take demand away from the natural industry and I think that’s why you see weakness in some of these independent producers at the moment. I would say the sentiment has gotten so low, it’s almost like there’s an implication that these companies aren’t gonna make it, I think it’s way overdone. I think if you couldn’t distinguish between a natural diamond and a lab created diamond, then I think all bets would be off. But I think as long as we can continue to distinguish between the two, and we have the detection technology readily available, and the natural industry continues to successfully market itself as a fine jewelry product and as a different product from a lower priced lab created diamond, I think the industry’s gonna be okay and it has a very long and resilient history, so I don’t think I would bet against the natural diamond industry.
Bill: Have you done any analog comparisons, like for example a woman with a lot of money wants a mink coat, and there’s the market for the artificial man-made mink coat, and then there’s the actual mink fur. Markets like that, do they kind of give us an indication of where this synthetic diamond market might go?
Paul: Yeah, I think you can actually just use another kind of gemstone is a better maybe analog. You look at you know, ruby, emerald and sapphires, and they’ve been available in synthetic form for decades now. And you can walk into your local jeweler and probably buy a flawless one carat emerald for $50. So they’re substantially cheaper, and it’s a completely different market than if you kind of went into that same store and wanted to buy a natural emerald.
So I think it is, like anything else, if people still perceive diamonds as natural diamonds, so when this new product comes to market that’s half the price, people kind of still think they’re buying a diamond but it’s a different product, because it doesn’t have that inherent rarity. And I think that’s important when you’re talking about a luxury product, I think if we’re talking about a diamond used for industrial purposes, I think the lowest priced alternative that performs the same is probably the one you’re gonna go with, but when we’re talking about luxury and the emotion attached to purchasing a luxury item, I think the inherent rarity and the inherent value of a natural diamond, because of the inherent rarity, kind of sets it apart. And I think that’s an important component of a luxury product.
Bill: I want to go a little bit more into investing in diamond mining companies, but before we go there, you mentioned in your introduction that the price of diamonds rose steeply in 2011. What was the cause of that?
Paul: So that was coming out of the global financial crisis, obviously there was a huge credit crunch throughout almost every industry. And that resulted in impairing of diamond production. So supply was coming off, and right around that same time, there was this surge in new demand coming out of China as consumers started purchasing diamond engagement rings for the first time. So you got this huge demand rush out of mostly China but also India at the same time we were seeing a decrease in global supply. And actually, diamonds were one of the fastest commodities to recover post global financial crisis because of this.
But that spurred exploration, and it spurred new mine development, and I think that’s kind of what lead to the price weakness now, we’ve actually had too much supply come online in the last five years, and I think the industry’s kind of working through that at the moment. But I think the opposite effect is gonna happen now, where prices have gotten low enough where the economics really don’t make sense to explore as aggressively and develop new mines as we saw five years ago, so looking five or ten years into the future, supply’s gonna come off quit substantially. And given that it takes usually a minimum of five to ten years to put a new mine into production, you can get a pretty good idea of what that supply is gonna look like in a five to ten year window into the future.
Bill: Do you have to look at the overall economy when you’re analyzing the future demand for diamonds because if most of the demand is coming from jewelry, then it’s more of a luxury, not absolutely needed commodity, so when you do your analyzing of what the demand will be, I assume you look at the macro economic situation as well?
Paul: Yeah, that’s right. When you kind of run the numbers and do the analysis, diamond demand historically has correlated very high with global GDP. So I think you can kind of use that as a basis, it gets a little bit more complex when you look at the emerging markets. So to kind of quantify this, the US represents 50% of global diamond jewelry demand, so the US is still by far the largest market. China’s approaching 20%, India’s approaching 10%. But at the current growth rates, it looks as if China and India will probably outtake the US as the largest market, probably over the next decade, decade and a half.
So I think that dynamic is kind of changing quite rapidly, and if we do see say a slow down or a normalization in the US I think you know, you look at India and China, I think that could potentially be the significant growth driver that the industry needs going forward.
Bill: When you look at the opportunity in investing in the actual companies themselves, you mentioned De Beers and there’s other ones, what are some things you are looking for in a diamond mining company right now that would make that an attractive investment to you?
Paul: Yeah, so I mean there’s only a handful of publicly traded diamond miners that are stand-alones. There’s a handful in Canada. What I would say is that most of the newer producers still have debt that they took out to build the mines, there were three new mines that commenced production in 2017, two were in Canada. The Gahcho Kué mine in the Northwest territories, it’s a 51%-49% joint venture between De Beers and Mountain Province Diamonds which is a publicly traded company. And then you have the Renard Mine in Quebec, which is wholly owned by Stornoway Diamond, which is also publicly-traded. So they both took on debt to bring on new mines that commended production in 2017.
And again, we’ve had relatively flat to moderately declining diamond prices for the last five or six years, and you have companies that kind of have debt in the balance, and I think it’s creating some concern, then you have institutional investors that are concerned about the potential impact of lab-created diamonds, potential economic slowing in a couple of years, ending the current economic cycle. I think that’s a concern. So I think kind of when you look at all these pieces of the puzzle, I think it’s legitimate for there to be some concern, but I think it’s gotten a little bit overdone.
I recently wrote an article, it’s available on my website, I put it on on April 5th. But I have a chart of diamond mining stocks over the last two and a half years, and if you kind of take a basket of these standalone diamond miners, and kind of weight them by market cap, they were down 17% in 2017, 29% in 2018, and they’re already down 14% this year. So I mean they’ve really been hit hard. And I think it’s overdone. So I think, you definitely want to take into account companies that are you know, kind of de-risk their mining operations and have a manageable debt load. But again, you’re dealing with mining, which is inherently a risky business. There’s a lot of, operationally, there’s a lot of things that can go wrong and then when you have a commodity price that really hasn’t been going in your favor, it can become complicated and difficult.
But I think more than enough of that risk has been factored into most of these names at this point, and I think the supply situation that we talked about before is gonna be supportive of prices. And I think if we have even continued moderate demand growth, I think the economics of some of these companies looks pretty good.
Bill: When you’re looking at a potential speculation in an early-stage exploration diamond company, what are you looking for, and what are some risks to avoid?
Paul: Yeah, I think it’s just like any other mining company, I think you know, management is key, the asset is key, experience is key. Being funded and have availability for additional funding if it’s needed. What I would say is you know, diamonds are a little bit different from say gold or copper exploration. The starting point is very vast, which makes exploration challenging, whereas most metals are found in volcanic or sedimentary rock formations, kimberlite can intrude pretty much any kind of rock formation so it’s really hard to narrow down deposits. And then you know, in addition kimberlite types where diamonds are found, they’re relatively small. And then once you actually do find a kimberlite you actually have diamonds, they’re diamond iferous. And then even fewer are economic.
So I mean, there’s certainly a relatively high risk reward here. And then once you actually do kind of make a discovery, the sampling process is quite rigorous and expensive. Given that diamonds lack fungibility, there’s say ten thousand different categories. You need to take a large enough sample to try to predict what the actual product mix looks like, meaning how many large diamonds are there, how many diamonds that are of good color and quality. So it becomes quite nuanced from that standpoint. And I think that’s kind of why some investors have shied away, because I think there’s an additional layer of complexity with diamonds that you maybe don’t have with gold or copper in that regard.
Bill: As you’re listening to us talk about diamonds, there’s an opportunity here as Paul said that this sector could be potentially oversold right now and for those that are willing to put in the hours of study and analyzing and researching opportunities, you could be rewarded nicely if the thesis is right and we see diamond prices rise, and some of these miners could have a nice rebound. Paul, as we conclude, could you share your contact information and how people can follow you?
Paul: Sure, I have information on my website, it’s www.paulzimnisky.com, I’m pretty active at Twitter, it’s @paulzimnisky. And if anybody wants to reach out with any questions, I do have my contact information on my website.
Bill: And you recently launched your own podcast, can you give us any teasers for some upcoming episodes and what listeners might expect?
Paul: Sure. I guess if you want maybe a more nuanced discussion of what we had today, you could give that a listen. I only have one up so far, but it’s available on iTunes if you search “Paul Zimnisky Diamond Analytics Podcast”, and there’s more episodes in the works.
Bill: Well thanks Paul, I appreciate you joining me today to discuss diamonds. Have a great day.
Paul: Thanks Bill.
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