FALLING LIKE A STONE

Edward Whitley reports that the bottom

is dropping out of the diamond market, with painful consequences for De Beers

THERE ARE TOO many myths about diamonds — that they are rare, magical, a 'girl's best friend' and 'forever' — and that De Beers, the legendary South African Company which controls the world dia- mond industry, is unimaginably wealthy. Diamonds themselves may he forever but the future of De Beers is looking decidedly flawed.

Just as with the secretive Reich- manns (who only two years ago were considered the world's richest family), everyone has always assumed that the Oppenheimers, who control De Beers and its parent Company Anglo American. are supremely rich. But although the cross-company shareholdings make their business empire virtually unin- telligible to the outsider, the simple facts are unavoidable — last December De Beers declared debts of almost $2 billion, partly secured on a diamond stockpile of $3 billion. De Beers valued this stockpile at $3 Killion, but it has subsequently grown to around $4.5 billion and the debts have also increased. De Beers Is running out of cash, but it is diffi- cult to see how they could use the diamonds as further collateral since even the thought that these dia- monds might come onto the market would greatly reduce their value.

De Beers has just admitted that it may cut its dividend for only the second time in its history, but, even so, one City analyst forecasts that it will face cash-flow problems by December and start testing its bankers' nerves in earnest. The stock market has already anticipated this risk — the shares have halved in value over the year.

De Beers' real problem is neither the recent Angolan diamond rush, which has been so dramatically photographed, nor the secret selling of Russian diamonds, which has been darkly rumoured up and down Hatton Garden. Both these problems seem easily containable. Indeed they could distract attention from De Beers' own

internal problems. In fairness to Julian Ogilvie Thompson and Nicholas Oppen- heimer, the current chairman and deputy chairman, perhaps these problems were inevitable.

De Beers controls 80 per cent of the world's diamond production and its intelli- gence about the industry — who is produc- ing, who is selling, who is buying — is omniscient. It would not have been too dis- turbed by the current Angolan rush (which will soon be reduced by the rainy season) because it is producing only small amounts of diamonds. Indeed there is nothing to stop De Beers from sending in its own men to buy up rough diamonds from the diggers in the Angolan open mines, where they change hands very cheaply. But even if all the unofficially found Angolan diamonds reach the diamond bourse in Antwerp, they will not exceed I million carats — less than 2 per cent of the annual diamond produc- tion of 100 million carats (142 carats equal 1 ounce). They will probably not exceed 1 per cent. It seems hard to believe that this could have a really damaging effect on the market. If De Beers was really worried about the Angolan situation, it would have postponed its new mine in South Africa, opened last month, which is forecast to produce 5 million carats a year.

It is amusing to an outsider to hear De Beers deploring the scenes in Angola and describing the dia- monds as 'illicit'. In fact, the scenes are very like the original diamond rush at Kimberley, where Cecil Rhodes made his fortune — 'with some very unlovely partners', as Jan Morris delicately puts it in Paz Bri- tannica — and so started De Beers, which was subsequently bought by the Oppenheimers. An 'illicit' dia- mond is identical to any other dia- mond in that it has been in the earth for 4 billion years and will make an equally beautiful engage- ment ring — it is just called illicit because it has bypassed De Beers' contractual grip.

Without a trace of irony, De Beers commented on the Angolan diamond rush: 'The problem started when the Angolan government passed a decree saying it was not illegal for citizens to be in posses- sion of diamonds. We took fright at that. It makes the policing of illicit diamonds very difficult.'

I asked Edmund Goldstein, presi- dent of the World Diamond Bourses, what he thought about an open market in dia- monds. His title led me to believe that he might favour something of an open market.

`It would be disastrous,' he exclaimed in his tiny office in Hatton Garden. 'As long as we have De Beers we will be all right. I have the greatest confidence that they will control the market. I am a great believer in things being properly controlled. There would be no recession if the Government had properly controlled the property mar- ket. The communists in the Soviet Union went a little bit too far, but they had the right idea — they just fell down on the dis- tribution side of things.'

By controlling the diamond market in the early days, De Beers made its fortune. According to Laurie Flynn's book, Studded with Diamonds, Paved with Gold (published next month), at the end of the last century De Beers was responsible for implementing the concept of migrant black workers and colour bars which flowered into apartheid. The ensuing low wage base kept profit margins exuberantly high.

Laurie Flynn writes, 'The dominant images of diamonds for anyone who has examined conditions in the mine are not those of romance and human love and affection, but of cruelty and injustice, inhu- manity and greed.'

Despite a pitiful wage base, the external cost of controlling the diamond industry has been gradually creeping higher. Throughout the 1980s, diamond sales grew and De Beers seemed to be doing very well, as its sales soared from $1 billion in 1982 to $4 billion in 1988 where they have plateaued. But this attractive sales growth masked a disturbing growth in unsold dia- mond stock.

The deal which may well prove to have been particularly costly for De Beers was the extraordinary one which it offered the Soviet Union. There are just three dia- mond mines in the Republic of Yakutia. It is a remote province in Siberia — the size of the United States but with a population of under I million. De Beers gave the Rus- sian Federation a $1 billion trade loan for the exclusive right to market around 60 per cent of its diamonds, and the $1 billion is being repaid not in cash but in diamonds.

'It was a marvellous deal from the Rus- sians' point of view,' Michael Spriggs of Warburgs, De Beers' brokers, commented.

'De Beers is over a barrel,' said another analyst. 'It has no idea how many diamonds the Russians are mining, it simply receives a certain number in a cardboard box every month.'

Not only does De Beers have to take delivery of the Russian diamonds to add to its absurdly high stock, but if it is to sup- port the diamond price, it is a keen buyer for the 40 per cent of diamonds which the Russians polish and sell themselves. It must he particularly galling to have paid the $1 billion in cash and then have to watch the price of diamonds collapse — the price of a I-carat flawless diamond (the benchmark in the industry) has dropped from $90,000 in 1986 to just $16,000 today.

I asked Richard Levine, the Russian expert in the United States Bureau of Mines in Washington DC, whether many diamonds could be smuggled out. He thought not: 'The security is very tight there and it is relatively easy to police. The diamond supply has been unaffected by the turmoil in the Soviet Union because Yaku- tia has remained part of the Russian Fed- eration. All diamonds arc still controlled by Moscow. The only difference is that now the revenues from 25 per cent of the pro- duction go back to the local authorities in Yakutia. Although people talk of the KGB smuggling diamonds, I think very little is happening. People just enjoy latching on to a juicy story.'

It is thus the consequences of the cash loan rather than the rumoured smuggling which is the core of De Beers' problem. It 'We're the chattering underclasses, squire . would be interesting to see what would happen if one of their banks asked for their money back and, when offered diamonds instead, had the temerity to ask for cash. Julian Ogilvie Thompson has roundly defended his management record. In a press release last month, he refuted criti-

cism that De Beers' marketing subsidiary, the Central Selling Organisation (CSO),

was losing its grip: 'The CSO control of the market is not slipping. In fact it is quite the reverse. By mopping up Angolan supplies we can say that more of the world's rough diamonds are passing through CSO than ever before.'

When I asked a De Beers' spokesman how long the company could finance this stockpile, he pointed out that they had sur- vived had times before. 'Over the last ten years world production of diamonds has doubled,' he said, 'and retail demand has also doubled. In a good market, we hold about seven months-worth of sales, and we move these stocks when demand increases. Given renewed economic growth, all our problems are solvable, but it is better that we hold these stocks rather than have them swilling around in the rest of the trade. But as one diamond dealer put it, 'They don't want more diamonds. There are dia- monds everywhere. Leaving aside Russia and Angola, there has just been a massive find in Canada which is said to dwarf the South African mines. De Beers is trying to keep diamonds as a luxury product when it is becoming plain that they are just a com- modity.' 'Harry Oppenheimer's spirit still stalks the corridors of De Beers,' said Michael Spriggs of Warburgs, 'hut now the company is facing an unprecedented problem and it is not immediately clear how it will come through it. This year with a stockpile of over $4 billion of diamonds, their cash will fall below $0.5 billion, possibly even less. De Beers may have to resort to debt financing, which brings their attraction as an investment into question. Indeed, you have to ask the question about their parent company — whither Anglo American?'

As if trying to answer this question, Harry and Nicky Oppenheimer are now in

Russia. Last week they opened an office in Moscow, but the implications of their trip go much deeper. 'You have to appreciate that it's the equivalent of John Major and his entire Cabinet going to a meeting,' an old De

Beers' employee told me. 'That's how important this meeting is. The OpPen-

heimers will be pleading with the Russians to stop selling diamonds. Nobody knows the size of the Russian stockpile of dia- monds — it could be as big as De Beers — and there is unprecendented demand for hard currency within Russia. Basically they've swallowed De Beers' $1 billion and they're after more. The question the Oppenheimers must face is how much longer they're prepared to support the dia- mond cartel.'

From its inception in the 1920s through to the 1970s, the highly lucrative diamond cartel helped fund Anglo American's other mining interests in gold, platinum and coal. But the diamond cartel has started to lose money drastically, just at a time when Anglo American has few major mining pro- jects coming on stream — apart from the new diamond mine in South Africa.

De Beers has just taken the unprece- dented step of reducing the number of dia- monds it buys from mining sources across the world from 100 per cent of production to 75 per cent. This, of course, is only stor- ing up further trouble for itself in the future because the diamonds will start stockpiling at the mines. It just emphasises the impact of De Beers' policy in building up diamond stocks throughout the last decade.

Whilst De Beers is doing what it can to tackle the problem of chronic oversupply of these supposedly rare gems, it has precious few answers to the plunge in demand. Sales in Japan and America, the major markets, have fallen as people have realised that there are many better things to spend Money on in a recession. As to their reput- ed investment value, diamonds yield no interest and their price has been falling steadily since 1986.

De Beers' answer to this crisis is to talk of China as the next great market. Like many companies which have dreamt of sell- ing just one tin of baked beans or one com- puter to every Chinaman, this is pie in the sky. China will remain a market of endless Potential — but no profit — for the fore- seeable future. Indeed, the whole concept 01 marketing diamonds to such a mass mar- ket rather gives away the. game that dia- monds are just a commodity in great Oversupply. If De Beers can persuade the Russian Federation to reduce its diamond produc- tion (despite De Beers itself increasing its own), and if the rains put a stop to the. Angolan diamond rush, then in a couple of Months' time De Beers will trumpet that it has restored its grip on the industry. If it can start selling diamonds to the Ameri- cans, the Japanese and, yes, a carat to each Chinaman would help, then De Beers may begin to shift its stock surplus. But a cartel survives on equal measures of exclusivity, control and confidence, and all are rapidly diminishing. Such an overwhelming stockpile threat- ens the diamond cartel which Sir Ernest OPpenheimer, Nicky Oppenheimer's

grandfather, so ruthlessly established. De Beers have failed to follow the premise which was minuted at a meeting with the South African government in 1930: For goodness sake,' reads the memo, 'keep out the newspapers and Parliament the quantity of diamonds that can he produced and put on the market. If you do not, it will alarm the whole market.' It was as clear then as it is now — dia- monds need not he forever.