Such firms are hard to analyse, they aren’t always run well and they rarely add value
Just when you thought it couldn't get any worse, another wave comes crashing down on the commodities space. Prices are getting hammered thanks to plentiful supplies and concerns about global growth (therefore equating to worries about commodities demand).
Metals are declining in value including aluminium closing below $1,600 per tonne for the first time since July 2009. Oil prices are retreating from their rebound seen earlier this year. Coal prices have shown that an already-depressed commodity still has room to edge lower.
Deutsche Bank's weekly report on commodities includes a dashboard image showing its view on commodity groups, with a dial that looks like a speedometer from a car. Every dial apart from industrial metals is pointing to the left, which indicates a bearish view on prices. The reason why the industrial metals group is singled out is down to several of the big constituents trading below their marginal cash costs, being nickel and aluminium, so miners could soon curtail output and prices may therefore stabilise.
New entrant
Anyone knowledgeable about commodities may not be surprised by these price trends, given that they have been in place for some time. Sadly, one of the few remaining bright spots of the market is now also succumbing to the doom and gloom. It is disappointing, but not a reason to panic.
Diamonds have long been seen as an area of solace for commodity fans but their sparkle is now fading. Demand has weakened for luxury goods and traders, cutters and polishers are struggling after a squeeze on credit. The world's largest diamond producer, De Beers, last week cut its 2015 production guidance for the second time this year to reflect market conditions.
De Beers and Alrosa, as the two biggest industry players, are generally considered as having supply discipline, making sure the market isn't flooded with goods when demand is weak. They hold auctions and buyers either bid or refuse goods. Diamond sector website Rapaport claims that De Beers' July auction saw more than 65% of products go unsold.
Alrosa says the price of its rough diamonds fell by 3% in the second quarter of 2015; its overall prices are down 6% since beginning of the year affected by a slowdown in the diamond market.
A difficult period
Petra Diamonds (PDL) has disappointed investors on several occasions this year with reduced earnings estimates, a result of it having to mine low-grade material pending a shift to higher-grade ore as part of a large development initiative.
On 27 July Petra disappointed again with revenue guidance, saying 2016's financial year would be $458 million versus analyst consensus of $520 million - primarily because of continuation of low grades from one of its big mines, Cullinan in South Africa.
Worst over?
FinnCap believes diamond prices are expected to remain flat 'for the next year at least'. While that is not very encouraging if you are running a diamond company, flat has to be considered good when most other commodities are in sustained decline. Investors must therefore keep an eye on the diamond sector.
Commenting on Gem Diamonds (GEMD) at the end of June, RBC Capital Markets said diamond price weakness may weigh on earnings and the share price, in particular amid concerns over the Chinese economy. Interestingly, Gem's shares went up 2.4% on the same day (27 Jul) that both Petra issued downgraded earnings guidance and China's stock market plunged by more than 8%.
Diamondcorp's (DCP:AIM) open offer to help fund work at its Lace mine in South Africa was nearly five times over-subscribed at the start of July.
Lucara Diamond (LUC:TSX) got $68.7 million from selling 14 diamonds in mid July, something that CEO William Lamb described as an 'amazing result, demonstrating not just the sustainable quality of the diamonds being produced but also
the robustness of the exceptional stone market.'
We don't expect to see a significant decline in diamond mining share prices as industry weakness looks minor compared with other commodities.
Seek quality assets (Gem Diamonds is our top pick) and companies whose management team are not chasing growth for growth's sake (Diamondcorp's primary focus is to generate cash for shareholders, not reinvest earnings into new projects). These companies are likely to be rewarded in the long term.