SMALL CAP IDEAS: Pent up demand for diamonds could boost small miners

Markets may be heading into a slow tailspin at the moment, but in certain places where the supply-demand dynamic remains heavily distorted, there are still serious opportunities to be found.

Diamond mining is a case in point.

Diamonds suffered significantly during the coronavirus crisis as the uncertainty around lockdowns, furloughs, employment and the broader economic outlook seriously tempered consumer demand.

That demand didn’t disappear, though. Rather, it became pent up, and once the virus restrictions eased, the market came back with a vengeance.

Diamonds suffered significantly during the coronavirus crisis but demand has picked up again

What’s more, for the first part of the year buyers were also flush with stimulus cash, and not yet concerned about inflation.

That dynamic allowed significant momentum to build in the diamond industry, and the first half of the year was a good one.

Inflation may now dent demand. But even so, the diamond mining sector will be insulated like few others, as diamond prices are still likely to run very high.

That’s because of the Russian invasion of Ukraine has had a severe impact on supply.

Around one third of the world’s diamonds are produced by Russian mining behemoth Alrosa. In particular, Alrosa specialises in the small stones that go around a larger one in the centre of a ring.

The world’s foremost diamond producer, De Beers, doesn’t produce much in the way of these smaller stones, and according to data cited recently by Bloomberg, prices of these have gone up by around 20 per cent this year.

In the old days, in times of market imbalance De Beers would just have released more stones from its fabled stockpile and a correction would have occurred forthwith.

But after the collapse of the Soviet Union and in the face of Alrosa’s rise to prominence, De Beers recognised that it could no longer control the diamond market in the way it used to, and that tying up capital in a stockpile was no longer a good use of shareholders’ funds.

Or at least, that’s what they said at the time. Now, though, even with De Beers mines producing at full tilt, there’s no chance that the company will be able to make up the shortfall caused by the ostracising of Alrosa from world markets.

Will Alrosa find a workaround? It may do. Russian relations with India remain on a reasonably firm footing, and it may be that Alrosa can channel significant supply through Bombay.

A truck drives amongst workings at the De Beers Voorspoed diamond mine in South Africa

A truck drives amongst workings at the De Beers Voorspoed diamond mine in South Africa

But this is an industry that knows how to track its product. True, the tracking capabilities now in place were designed to mitigate against conflict diamonds produced in Africa. But those tools can still be brought to bear to keep Russian stones out of Western markets. Buyers are interested in provenance anyway. Now governments will be too.

So what does this mean for the miners?

Last month, unsurprisingly, De Beers reported continuing strong demand for rough diamonds. The fourth De Beers sales cycle of 2022 realised $604million, according to De Beers owner Anglo American.

That’s more than $220million ahead of the $385million reported for the equivalent fourth sales cycle in 2021 and bring sales so far in 2022 to approximately $2.5billion.

Broker SP Angel reckons that that means De Beers sales at this point in the cycle are at their highest level since 2016.

And it’s not just the majors that will do will. Smaller companies are set to benefit too, although this isn’t always showing up their share prices. Some are benefitting.

Shares in Gem Diamonds (45.5p), for example, have just about doubled since the worst of the Covid ravages, and in the intervening period between then and now have been even higher.

Petra Diamonds (93.5p), meanwhile, is also on the up after its complex restructuring, and its shares are just shy of 30 per cent better when compared to a year ago.

The ongoing exploration programmes from the likes of Karelian Diamonds (2.35p) and Botswana Diamonds (0.95p) are also attracting some attention, but not really setting the market alight, even though Karelian’s recent identification of multiple Kimberlites in Finland could be a real game changer.

And earlier in May Gem Diamonds and Botswana Diamond failed to complete a transaction on the Ghaghoo project in Botswana.

Even Lucara, the standard-bearer of the Canadian independents, remains subdued, in spite of a 28 per cent boost to revenues in the first quarter of this year. So, for now it’s a mixed picture.

But if the buyers aren’t coming in for diamond companies right now, what that could mean is that there will be a stampede to catch up when the valuation mismatch between the current shortage of supply and diamond company share prices becomes more widely appreciated.

And that might mean a re-rating is on the cards. We will see.