Tag: synthetic diamonds

Temporary Color Echancement

Potential Game Changer for Industry and Grading Labs 
By Chaim Even-Zohar

The advent of a reversible (temporary) color enhancement treatment in the diamond market potentially presents a radical “game changer,” comparable to the discovery of the Yehuda Treatment in the early 1980s, or the General Electric/Lazare Kaplan HPHT-color enhancements of the 1990s.

In these methods, the color change is stable and permanent. A new treatment, that may cause an up to three grades change of color in diamonds that will revert back to its original color, may greatly impact the way the business is conducted.

GIA scientists and other gemologists are working around the clock to discover the treatment method as well as the triggers that activate the reversal process. This article, in a cautious manner, looks at the little that is known so far. It is a scary and quite unsettling story.

The Story So Far

Two Israeli police investigators spent most of their time recently at the Gemological Institute of America (GIA) laboratory in Ramat Gan, Israel. The Israel Diamond Exchange (IDE) called in the police after the GIA issued its alert noting that the “GIA reasonably suspects that approximately 500 colorless to near colorless diamonds submitted primarily to our laboratory in Israel potentially were subjected to an undisclosed temporary treatment.”The geographic location of the discovery is not relevant: the existence of the unknown treatment potentially affects each and every diamond center. The Israeli bourse acted resolutely. It took the almost unprecedented step to call law enforcement into the rather closed diamond community, when learningabout “tradingtreateddiamondswithout disclosure in the Israeli diamond and trade,” and trading with “GIA diamond grading reports that misrepresent the diamonds’ true identity.”

A New Precedent

As far as this writer is concerned, this is the first time ever that the Israeli bourse’s internal disciplinary bodies were bypassed regarding the handling of such suspicions. They were, instead, catapulted straight into a full-fledged police investigation. This investigation is being conducted in coordination “with the appropriate state authorities,” which have been called in to “take the needed measures,” said a statement released by the bourse.

At this point in time, we find it hard to understand what the police can contribute to the GIA-created imbroglio, except perhaps for generating short- term positive public relations overseas. Moreover, if GIA clients tried to defraud the GIA, i.e., if they found a system through which the GIA would unwittingly issue an overstated diamond certificate, why didn’t the GIA go the police itself? Why was that left to the Israel Diamond Exchange to do?

GIA: ‘We Followed Normal Protocol’“As always in these situations, we first apprise the presidents of the WFDB and IDMA, and, in this instance, also of the Israel Diamond Exchange,” explained GIA Senior Vice President Tom Moses. “The bourse decided to call in the police. If they hadn’t done this, we most likely would have done it ourselves. In any event, we are fully working together with the police, as is evident by the long hours spent in our lab talking with our people.”

Incidentally, it’s not clear why the police were spending so much time at the GIA lab; most likely, they are getting a complimentary crash course in gemology. Meanwhile, we have learned that the police are checking the prices for which the buyers bought the suspect stones. If they paid substantially below market price for them, then it may be assumed that the buyers knew they were buying misrepresented goods. If they paid full market value – they may have been “had,” provided that the stones are indeed treated.

This story is still developing and it has only been a few weeks since the GIA issued its initial announcement. At this point, the GIA and other scientists have not yet been able to conclusively determine the nature of the “undisclosed temporary treatment.”

Some Skepticism:

A Cover-Up?

Some skeptical diamantaires retort that this whole incident “seems like a giant cover-up for some GIA clients (or maybe even just one client) bribing some GIA employees and inducing them to give color upgrades… but then were caught.” Some diamantaires are also angry with the GIA for specifically identifying Israel in its statement.

The local Israeli GIA lab director vehemently rejects any suggestion that the police are actually investigating the GIA itself. Tom Moses also categorically and unequivocally denies and dismisses any talk about GIA wrongdoings or cover-ups – and I believe him. Unfortunately, what I believe is irrelevant.

What we have now is a situation that demands conclusive, unequivocal answers, and the onus to provide these answers falls completely on the GIA. This is the only way to restore market tranquility. Moses assured us that all of the institute’s findings will be shared fully with the industry.

Unknown Color Treatments

In conversations with Tom Moses, he reminded me that, historically, every decade brings new color treatments that are, initially, quite unknown.

One recalls the Yehuda Treatment in the early 1980s, or General Electric and Lazare Kaplan’s colorless diamonds (called Bellataire) in the 1990s. It took the gemological community some time to compile the “protocols” or the ways to identify, detect, understand the materials, durability, permanency of stones subjected to these treatments. One also needs thousands of stones to study before getting a comprehensive understanding of all gemological characteristics of each treatment.

It might well be that the color enhancement method that is being used by the suspected parties is a variation on some of the known methods; it might also be something entirely different.

The inventors or users of the treatment method in question are not coming forward, nor are they presenting their expertise for analysis. That, by itself, hints at something about the bad intent underpinning this activity. It is treatment meant to defraud. It is, indeed, a matter for the police to get involved in.

The essence of a ‘Temporary

It is quite scary to think that there is an unstable, reversible, and temporary diamond-color- enhancement method in the market that is escaping detection. In fact, it apparently doesn’t leave any traces!

The GIA describes the treatment in its alert as “a process that temporarily masks the inherent color of the diamond and can lead to higher grading. The color difference can be as much as three grades.” Such a color difference easily translates into 60-70 percent of a stone’s value.

The vast majority of suspect stones in this story are above 1 carat, with some being in the 3-5 carat ranges. The Israeli GIA lab only grades stones up to 2.99 carats in size; therefore; the larger stones were graded in New York or California. The GIA confirmed to Diamond Intelligence Briefing (DIB) that the US submissions contained stones all belonging to some of the same four companies that were publicly identified in the (May 12, 2015) GIA alert.

A Diamond Recall

The GIA has known about this temporary enhancement for probably a few months – ever since an innocent third party brought in a stone that clearly showed a color mismatch compared to its own certificate. Though the GIA alert refers to 500 suspicious certificates, only 424 of them were included in the lab’s list of diamond certificates that require rechecking.

The reason for the difference is that some 76 stones were already rechecked before the alert was issued. The majority of these rechecked diamonds turned out to have gone back to their original (and natural) color – up to three grades lower. Apparently, the “best” color seen in the treated stones is “E” – though there might somewhere be a “D.” Most of the treated stones are “E” and below. The problem is real – not imaginary.

In fact, sources at the GIA intimate that the practice may have started somewhere around the end of 2014. In any event, the GIA has issued a recall that includes diamonds that were certified by the GIA in the past six months. What the GIA did was simple: as soon as it had identified some parties that had submitted the undisclosed treated stones, all certificates issued to these companies were considered suspect. They all were recalled – and voided.

Possibilities

It is quite possible that other companies were aware of the treatment. It is also quite possible that there may be other companies out there still applying this same treatment method. In addition, a possibility is that several additional companies could have made submissions of stones to the GIA with temporary color enhancement on behalf of the companies already identified. (Indeed, from the four identified companies, one has stated that it did “a favor” for one of the others, as they had reached the company submission limit of stones set by the Israeli GIA lab. The company had never even seen the stones…)

It is a real and justified fear that this incident might just be the tip of the iceberg. If so, this may have made it necessary for the GIA to go public – even before having all the details about the process.

Temporary:

From a few minutes to a few weeks

Color enhancement is one thing – permanency of the change is a different matter altogether. An unstable diamond color will greatly affect its price – and become a source of potentially enormous legal and commercial trouble. (It already has. A buyer in Israel wanted to return a stone he had bought in the bourse; the seller refused to take it back. The buyer wants to cancel the post-dated check given in payment. Cancelling checks is prohibited. This is going to be an interesting arbitration.)

GIA Laboratory Alert

May 12, 2015 – GIA reasonably suspects that approximately 500 colorless to near colorless diamonds submitted primarily to our laboratory in Israel potentially were subjected to an undisclosed temporary treatment.

GIA believes that the treatment is a process that temporarily masks the inherent color of the diamond and can lead to a higher grade. The color difference can be as much as three grades. GIA has not yet identified the treatment process, but this is being actively researched. At this time, the diamonds treated in this way have been submitted by just a few clients.

Report numbers with this suspected treatment are listed here (see http:// www.gia.edu/gem-lab/laboratory-alert- may-2015) and we ask anyone who has purchased or holds these diamonds to please re-submit them to any GIA location for review. GIA will expedite the service, and no fee will be assessed. We have terminated submissions from the clients who have submitted these diamonds to GIA and have notified the appropriate trade bodies.

It is well known that exposure of a diamond or gemstone to an artificial source of radiation will change its color. This is sometimes followed by a heat treatment (annealing) to further modify the color.

One esteemed gemologist, Dr. Sharon Ferber, D.G., G.G., noted in one of her studies that,“The problem with irradiation is that although the colors are attractive, there is some question about their permanency and the health hazards. Irradiated diamonds are guaranteed to survive the normal, everyday wear and tear, but the color may change when the stone is exposed to high heat.”

Is irradiation something that can always be detected? Yes and no. There are many diamonds that will always show some form of irradiation, mainly because of their mining source. Sometimes, the proximity to a uranium mine enough reason for irradiation in diamonds to show up.

“It all depends on the doses,” says a GIA source. Massive irradiation would turn a diamond totally black. Small doses may not always be visible. But irradiation is mostly used for colored diamonds. Although perhaps not any longer – we still don’t know.

This new “temporary” unstable color enhancing feature is an entirely different ballgame. Color changes can be made in several ways – though this is not the place to discuss these. However, HPHT color enhancements, Yehuda Treatment, and other known methods bring about permanent, irreversible and durable color changes. In some instances, a color may change again by some treatments – but they don’t revert back to their original color. This is definitely a game-changer for the entire industry.

Seeking the ‘Trigger’ that Activates the Reversal Process

If the submitter knows that the stone may revert within a few hours or days to its original color, he would use the GIA’s more expensive “express checking service,” to get his certificate, while the artificially-induced grade still appears. The Israeli lab director confirmed, however, that some of the suspect stones were submitted in the ordinary process, which would actually suggest that the “time framework” before reverting back to original color is longer than currently is assumed.

What we have learned is that in most instances, the diamond reverts to its original color within two days, but some last only for a few hours. If that’s the case, what accounts for the time difference? Sources within the GIA explained that it depends on a yet unspecified “trigger” that activates the reversal process. That “trigger” can be many things: the exposure to a specific source of heat, exposure to a (shortwave or longwave) ultraviolet fluorescent lamp when checking the fluorescence of a diamond, or exposure to certain other light sources.

Someone familiar with the rechecking of the 76 treated stones (before the GIA publicly issued its alert) confided that in some instances, the stones actually went back to their original color during the examination, while still at the GIA in New York. In other instances, the gemologist had started to work on a stone in the afternoon, and when he or she came back the next morning, the grade was lower.

This actually gave rise to some interesting possibilities. At the GIA, every stone is “cleaned” before being examined. Certain solvents are used in the cleaning process. It may well be that the “trigger” to activate the reversal may be a chemical used in the cleaning solvent. It is just one more area for investigation.

The Israel Diamond Exchange, for whatever reasons, seems to think that the fraudulent method is coating-related. The bourse’s website carries a regrettably misleading headline: ‘Update Regarding GIA Coated Diamonds Case.’ That’s jumping the gun.”

If, indeed, there is a“trigger”that activates the color reversal, it is quite logical that, in some instances, the change back to its original grade may be a matter of hours, days or even weeks or more. It all depends on what the triggers are – and when the stones are exposed to them.Coating and Deep-Boiling

After interviewing members of Israel’s bourse, it seems that many diamantaires – for whatever reason – believe that the color change comes from a specific deep-boiling process. They assert that some chemicals were added to the customary deep-boiling process that removes the remnants of black ink, fingerprints and other dirt from the polished diamonds.

Others think it is a coating process. Indeed, thin- film coatings are sometimes used on diamonds to change their color. Crude yet effective coatings can also include the use of permanent ink markers along the girdle surface of a diamond, causing its face-up appearance to be affected by the color of the ink used.

We are even familiar with coating methods that use metal oxide films. If I am allowed to speculate: one can even “stick” or “paste” some infinitely small material on several places on the diamond’s girdle, which will lead to a light distortion giving the stone a better color, and thus a better grading. When the diamond reaches the jeweler, who uses heating materials to set the stone into its setting, the material may unwittingly be removed.

The Israel Diamond Exchange, seems to think that the fraudulent method is coating-related. The bourse’s website carries a regrettably misleading headline: “Update Regarding GIA Coated Diamonds Case.” That’s jumping the gun. The GIA doesn’t know yet if a coating was applied to the diamonds under investigation. If the Exchange knows something that the GIA doesn’t, it should immediately inform both the GIA and the public.MOUNTING LEGAL AND COMMERCIAL PROBLEMS AHEAD

With due caution, let’s have a look at some of the legal, commercial and gemological aspects of the known facts. Some of the five companies mentioned in the GIA alert are considering libel, defamation and/ or damage actions against the GIA. They have acquired some of the best lawyers one can find.

Rightly or wrongly, gemological labs have lately become the “preferred” target of law firms that are advertising class-action lawsuits against wrongdoings. However, the GIA seems to have done its homework – and we cannot find legal flaws in its carefully crafted announcement. Moreover, it apparently acted in full accordance with the agreed terms and conditions applicable to all of its grading activities.

Intentional fraudulent diamond upgrading provides enormous windfall profits to unscrupulous industry players. Let them discover that crime doesn’t always pay…

We applaud any legal actions if they lead to the removal of rotten apples from our industry. However, the GIA doesn’t belong in that category. It has become the industry’s standard-setter and benchmark. And its integrity needs to be protected. That is most of all its own responsibility.

However, it also needs to labor day and night to find ways to detect these treatments. I understand that the lab has already asked outside scientists to join them in the search for detection. But until it finds the answers, any color grade on any diamond report by any lab may become questionable.

If most stones revert back to their original color in two days, all labs should hold stones for that period before commencing grading. And, if the period for the color change takes longer to take effect, stones may have to be held by all labs, gemologists and appraisers for several weeks before they are released.

Currently, the diamond business is in bad shape. Bad news seems to hit us with ever greater frequency. There is a tendency to “smooth things over lest we negatively impact trade sentiment and consumer confidence.”

Though we don’t believe in magic, the GIA’s early assurances that it is in control of the detection issue – and has shared this information with all labs and industry bodies – may well be the best news we can hope for at the moment. Tom, if you’re ever able to pull off miracles, this is the time to do so.

IDE Issues Announcement on GIA Lab Alert

On the morning of May 13, 2015, The Israel Diamond Exchange (IDE) called an extraordinary meeting of its board of directors, with the participation of the presidium of the Israel Diamond Manufacturers Association (IsDMA); the IDE’s Head of Security, Israel Vantovsky; Police Commissioner (Ret.) Yossi Sedbon; and the IDE’s Legal Counsel, Adv. Shmuel Ini.

Expressing indignation and resentment, meeting participants resolved to identify the suspects who distributed close to 500 high-quality, polished diamonds suspected to be treated in the Israeli diamond trade, without disclosure, and with GIA diamond grading reports that misrepresented their true identity. The meeting therefore decided to act immediately and, in coordination with the relevant parties in the bourse and the appropriate state authorities, to take the needed measures.

To expedite the process, the board decided to delegate the handling of the case to a number of board members, together with the IDE’s advisors and counsel.

The Exchange will provide further updates as they become available.

w IDE Announcement about GIA Coating Case

The Israel Diamond Exchange released a further announcement following the alert issued by the GIA regarding stones that had been submiited and received reports that are suspected to have undergone a color treatment process.

The IDE said that following a meeting of management on May 13, it is continuing to deal with the issue and is taking the following steps:

We provided briefing sessions for authorized state authorities with a panel that was especially established for the purpose with the following IDE members: Meir Dalumi, Shalom Papir, Loni Grinker and Moni Bachar along with legal counsel and retired former police commander Yossi Sedbon.

We held coordinated discussions with World Federation of Diamond Bourses President Ernie Blom and with presidents of diamond exchanges around the world.

We issued an announcement to all the exchanges and relevant bodies in the global diamond industry.

We carried out an evaluation of the situation with media advisers and briefings for journalists.

We asked all IDE members to turn to the Legal Department regarding transactions carried out for stones that were on the GIA list. We also received reports that there were no problems with some of the stones that were on the list.

The IDE said it would continue to inform the diamond public regarding new developments.

The notice was signed by IDE President Shmuel Schnitzer.

Meri Dalumi, the chairman of the IDE’s Legal Committee said that any diamonds traded that are on the GIA list should be handed over to the IDE’s Legal Department for guidance about what steps to take. Trading is not allowed for any stones on the GIA’s list. Anyone in possession of such stones is required to submit them to the IDE’s Legal Department.

ALL SORTS OF DECEPTION 

From passing off lab-grown diamonds as natural, to playing around with color, there have been more than a few cases of dishonesty in the diamond and gem industry.

One sadly common type of deception is the practice of “masking” whereby a lower value large Type IIa br

One sadly common type of deception is the practice of “masking” whereby a lower value large Type IIa brown stone is treated with a detectable HPHT (high pressure, high temperature) treatment and becomes a D color with F clarity.

But how is this deception hidden from the consumer? According to Chaim Even-Zohar, after the brown stone has been transformed into a perfect white diamond, it is subsequently subjected to irradiation, which slightly alters the diamond’s crystal lattice and knocks some carbon atoms out of place, not because it needs it, but purely to mask the HPHT treatment.

Once this is done, says Even-Zohar, it is virtually impossible for a laboratory to conclude that the stone started out in life as a cheap Type IIa brown, especially as only a few very experienced labs (GIA, HRD, De Beers Research Center, and some others) have the ability to discover “masking.”

The Exchange will provide further updates as they become available.

Quite the biggest deception involves passing lab-grown diamonds off as synthetics. Recently, undisclosed diamonds have been finding their way to India from China.

Earlier this year, the Surat Diamond Association (SDA) recovered 110 synthetic diamonds from a packet belonging to two diamond traders operating from the Mini Bazaar diamond market in Varachha.

This is the first time that synthetic diamonds have been discovered in the diamond-manufacturing city.

SDA president Dinesh Navadia said the stones were cut and polished in Bhavnagar. He added that the Natural Diamond Monitoring Committee (NDMC) set up by the Gems and Jewellery Export Promotion Council (GJEPC), is looking into the issue. This committee was established after a huge quantity of synthetic diamonds was detected in Mumbai in 2013.

But, it is not just diamonds that are subject to undisclosed treatments. In 2012, the American Gemological Laboratories (AGL) announced that it had identified a number of Colombian emeralds that have undergone irradiation treatment.

Although rumors about treated emeralds had been rife, the lab said this was the first time it had received stones that have been identified as being irradiated – a procedure that was first shown to modify the color of natural and synthetic emeralds nearly 20 years ago.

AGL said in a release that although the color of the emeralds was slightly unusual for a typical Colombian emerald, color alone cannot distinguish treated gems. Instead, detection is most effectively carried out using a spectrometer (an instrument used to measure properties of light over a specific portion of the electromagnetic spectrum) since the treatment may produce different types of defect centers that absorb in the ultraviolet region of the spectrum.

“Interestingly, we also noted that these emeralds had been clarity enhanced by introducing a polymer-type resin into fissures to reduce their visibility,”said Christopher P. Smith, president of AGL.“So these particular gemstones had the standard emerald enhancement of clarity, as well as an additional enhancement of irradiation.”

Download the PDF: Idex Online – Temporary Color Enhancement

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A Splintering of the Pipeline: The Economic Threat of Synthetics on the Diamond Producers

Will man-made diamonds increase the midstream bargaining leverage over rough suppliers?

Is it a core objective of the newly created Diamond Producers Association (DPA) to fight against synthetics? The impressions shaped by the publicity around the DPA give ample reason to think so. Two of the larger members of the organization tell me in no mistaken terms that this is definitely not the case. In fact, one DPA participant told me: “I challenge you to provide me with DPA publicity and interviews by members that stresses synthetics. Unauthorized and incorrect comments leaked before it was even launched and relayed by the press gave that impression, but none of the meetings we have held, discussions we have had, and for that matter comments we have made to the press is in line with your statement that the ‘fight against synthetics’ is at the center of theDPA’s objectives. [It] is just not the reality – take it from someone who has attended and to an extent led all of these discussions,” he added.
I checked the official DPA launch press release and studied the infant organization’s Articles of Association, and, indeed, the word “synthetics” doesn’t appear. But if the DPA spokesperson is right, then one must conclude that the launch of the DPA was done in a grossly inept manner from a public relations and damage-control perspective. Like it or not, every organization develops a reputation that is based on people’s perceptions. Images and reputations may take years to form – and a wrong perception can be difficult to repair, if ever.

DPA in the News – Inaccurate Coverage?

Let’s look at the publicity surrounding the new Diamond Producers Association. In early March, Bloomberg reported the headline: “Diamond Miners Meet in Private to Discuss Fake Gems Issue.” This article’s opening sentence read: “The world’s biggest diamond producers, increasingly threatened by cheaper manmade stones being passed off as the real thing, held a private meeting this week to create their first-ever industry association.”

A De Beers e-mail was then cited that confirmed: “Subjects discussed [in the private meeting] included diamond marketing, industry research and the threat to consumer confidence from undisclosed synthetic stones entering the market.” [There are already organizations to fight this fraud – they are called F.B.I., police, Interpol, etc.]
After the formal launch of the DPA in May, the Wall Street Journal also ran an article headlined: “Diamond Producers form Group to Fight Synthetics.” It reported that “a group of diamond miners is banding together to market its product and counter threats such as the expansion of synthetic stones.

Missing DPA Clarifications

If, as I’ve been told, fighting synthetics is NOT at the center of the DPA’s objectives, then why didn’t these leading newspapers and news services – whose reports were reprinted in tens of thousands of places within hours if not minutes after publication – get an immediate DPA response with corrections, clarifications and explanations? Not one of the seven diamond miners (Alrosa, De Beers, Rio Tinto, Dominion, Lucara and Gem Diamonds) saw a reason to react, to clarify? Even as these lines are written, such a DPA clarification hasn’t been published – so they shouldn’t take issue with those who felt these reports were accurate.
If the prime motivation behind the DPA is category promotion of natural diamonds, why didn’t this appear in the news headlines? If my perception of the DPA is wrong, then I am not certainly not alone.
The success of the DPA wholly depends on its credibility. Their promises of “enhancing confidence in diamonds,” their research findings, etc., must all align with actions that back up their statements, which will make the organization trustworthy; after their members “talk the talk,” they must also “walk the walk.” Swift dealing with inaccurate reports is a crucial imperative.

Click to read addendum: The Diamond Producers Association Limited

Quantifying the Synthetic Threat to Producers

Leaving the DPA aside for a moment, perhaps the time has come to differentiate between the threat posed by synthetics to producers (the upstream mining companies) and the downstream players (the manufacturers and retailers). In trade debates, it is “overlooked” that synthetic diamonds represent, first and foremost, a threat to natural diamond producers – maybe even an existential threat.

While reviewing current challenges facing the industry, Alrosa President Andrey Zharkov, one of the DPA founders, recently noted in particular “the synthetics issue,” which, he said, “we believe has already started to affect the market.” While stressing that various “global fundamentals could give us confidence in the future,” he added that “there are few things that could easily destroy all these forecasts, among which are synthetics, which can become a problem.” [In fact, Alrosa’s 2014 annual report identifies “the emergence of cost-effective methods of producing synthetic gem-quality diamonds” as a principal risk which may trigger “a loss of profit.”]

Danger of Product Substitution

In the diamond value chain, the inherent danger of product substitution from outside the diamond mining industry is greatest to the natural diamonds miners, which, until now, has not really faced competition and, especially, was never exposed to real price competition. No other sectors of the diamond pipeline (manufacturers, jewelers, etc.) produce (i.e., mine) rough; they merely manufacture rough and sell the resultant polished. Their profits come from the margins of the added value. These manufacturers and jewelers can continue to do what they do when manufacturing and selling synthetic diamonds – maybe even at higher profit margins. As one industry leader recently told a Tel Aviv diamond conference: “On every dollar I have invested in synthetics, the returns are far higher than any dollar invested in natural diamonds.”
This comment underscores that “threats” posed by synthetics for the manufacturers and retailers are not only far less, but are also quite different from those faced by the natural diamond producers. At the end of the day, for some of the manufacturers and retailers, manufacturing and selling synthetics may turn out to be quite beneficial – especially when one is focused on the bottom line.

Click to read addendum: Defining Economic Substitutes in Each Value Chain Segment

The Industry’s New Choices

The asymmetry (or lopsidedness) of the synthetic threat will actually increase the leverage (and bargaining power) of the diamond manufacturers (sightholders) over the diamond producers. Moreover, the “threat” to the producers – which they now apparently fully recognize – will impact their marketing behavior and mining strategies. For starters: they should start ensuring that their customers will earn better margins, lest they may be lured away to more lucrative disclosed or undisclosed synthetic manufacturing or marketing.

Let’s tackle the “politically incorrect” view of this issue systematically. The producers have conditioned the industry to believe that “what’s good for the producers must be good for all of us.” While that may have been the case in the past, it certainly is not today. As De Beers CEO Philippe Mellier aptly said in a recent speech: “And we should make no mistake – the world is not just changing, it has changed.”
The midstream and downstream now have choices that they didn’t have before. From a value perspective, these aren’t pleasant choices between equal products. For many of us, it is a choice that one hopes would not exist – but it does. And for many, it might be the difference between the life and death of their companies.  In the words of one industry leader, there clearly is no “one size fits all” approach to success.

Click to read addendum: Long Memory, Short Memory, Amnesia

Oligopolistic Supply Side Taking Joint Actions

In an oligopoly setting, the diamond producers recognize a certain interdependence – some may be leaders, others may be followers (especially on rough prices). One producer may react to the actions of others in quite a measured manner to preserve the interests of all of them. According to one of the world’s greatest authorities on competitive strategies,Harvard University Professor Michael Porter, the highest profits are generated by a cartel, while an oligopolistic setting provides the second largest margins. In a truly competitive market, prices go down to the lowest sustainable levels.
The producers’ shared cartel history has made them more aware of ethics and reputation, and very careful not to be seen as acting in collusion with each other or coordinating policies, etc. In fact, laudable efforts were actually made to create product differentiation (of which the Forevermark is a good example).
Nevertheless, the diamond producers have used their oligopolistic powers to the fullest,having successfully driven up rough prices to such an unrealistic level as to actually endanger the economic sustainability of their very own clients and other midstream and downstream levels.
But, through it all, they have refrained from showing too close of a cooperation. So why, all of a sudden, did the successful oligopolistic producers decide to once again create a joint framework – which is quite risky from a competition law perspective? [See box on “memory”]
We believe that synthetics have a lot do with this decision. Why? Because for the first time in their 100-year-plus history, the diamond producers are threatened by product substitution – man-made gem-quality diamonds.

Product Substitution

However, let me stress again, one of the DPA’s participants, Rio Tinto’s Jean-Marc Lieberherr, disagrees with me – and I respect his views. We can disagree.  Says Lieberherr: “Synthetics is one possible substitute, but believe me, other luxury brands, electronics and travel are far greater threats to the sector and we all share this diagnostic.”
I sense that the producers are carefully presenting a confusing message. The DPA puts other luxury products and synthetics under the same umbrella term called “substitutes.” However, these are entirely different issues. Of course, other luxury items (including vacations, etc.) all compete for the same discretionary (extra) disposable income on the retail levels.
Irrespective of synthetics, there is a need for promotion, as diamond jewelry is losing its share of the consumer’s luxury wallet.  The time-honored mantra calls this “consumer confidence” in diamonds; though what it really means is getting consumers to prefer diamond jewelry over buying new iPhones, iPads or Louis Vuitton bags. I do not think this is necessarily a confidence matter; it is a matter of conscious choices among a variety of very nice and attractive alternatives. It is competition among products, which is not the same as product substitution.

Effective Product Differentiation

Synthetic diamonds are an entirely different story. Their impact on the diamond value chain – on the manufacturers and traders – is not comparable to Louis Vuitton handbags. When competing against luxury handbags, the entire diamond value chain functions as a single delivery mechanism. In contrast, synthetics fragment this very diamond value chain. This is why the producers are worried.
Here, too, producers tend to think differently. “The challenge posed by substitutes requires that they be identified and that our product be effectively differentiated so that the value in use for the consumer is clearly higher vs. synthetics.  It is wrong to assume that synthetics perform exactly the same function as natural diamonds and are therefore perfect substitutes,” I was told. Many may disagree.
“Positive differentiation of our product is one obvious objective of the DPA. Luxury branded goods do not think in terms of marginal cost.  It is up to us to compete in that league.  It is incorrect to think that the synthetics will provide the same value (i.e. satisfaction, feeling of wealth, feeling of happiness) to consumers.  It is all a matter of marketing,” I was further told.
Assuming there is considerable truth to this – it hasn’t stopped some three dozen retailers from starting to offer synthetic (man-made) diamonds alongside natural diamonds. Are they differentiated? Yes, in most instances. At least for now.

Synthetics Increase Bargaining Power of Rough and Polished Buyers

At a time in which Indian diamond traders are talking about boycotting producers and to postpone their rough purchases for a month, it is clear that the users of rough quite desperately seek to enlarge their bargaining power over the producers. Oddly enough, and maybe quite unfortunately, gem-quality synthetics may do just that – at least to some extent.
For the first time in the history of the natural diamond producers there is a “product substitution” opportunity within the pipeline.  A diamond product that gives diamond manufacturers and traders, distributors, jewelry manufacturers and retailers a choice. A purchase choice to be precise.
For instance, a diamond manufacturer in Surat employing a thousand workers cannot shift excess or idle production capacity to handbags or watches. He can, however, decide to cut and polish gem-quality rough synthetic diamonds – and he will do so if he believes that, in the long run, this will enhance his profitability, and that he can enjoy greater margins.
The pipeline’s downstream has suffered enormously eroded margins. This is primarily because of the rough placing powers exerted by the natural producers. This behavior has caused the rough prices to be totally out of balance with resultant polished prices.
What do synthetic diamonds do to natural diamond producers? First of all, synthetics erode the bargaining power that producers exert over their clients. It gives diamond manufacturers a choice to get a supplier outside the natural diamond chain. This is true for his clients – the retailers ־ as well. They have an alternate diamond supply choice.

The Benefit of Synthetics as a Product Substitution

Michael Porter has stressed that, in a very broad sense, all industries are competing with other industries producing substitute products. Until recently, diamonds were probably the sole exception as there was no product substitution. Therefore, on the consumer level, its rarity became a major source of its value. The fact that there was no substitution hampered manufacturers, which, until a few years ago, employed some one million workers. These manufacturers couldn’t shift their excess manufacturing capacity to a substitute whenever there was a lack of rough supplies.
Producers tend to ridicule those who are willing to buy rough at loss-making prices, arguing that losses result when downstream players are not efficient or don’t create value. Meanwhile, the manufacturers had to measure the “loss” of laying off (trained) workers, of losing manufacturing capacity, against the “loss” inherent in manufacturing the product. The decision to purchase loss-making rough may be labelled as “insane” – but it is far more rational than one might think. Producers could, can, and still are “happily” selling rough at uneconomically high prices, dismissing criticism with statements that “producers will look after their own best interest and the midstream sectors should do what is best for them.”
As a product substitution, synthetics offer the manufacturers a way to reduce their (and the industry’s) total dependency on only one product – natural diamonds. While hitherto these needed to be sourced from an oligopolistic supply structure, this won’t be the case anymore. Gradually, as the process is still in infancy, the industry will have choices. It will eventually have a lower cost and higher margin alternative. This is not just theory – this is already happening.

Click to read addendum: Two Worlds Apart: Forces Impacting Competitive Industry and Oligopolistic Producers

Producers United Again

My colleague Pranay Narvekar and I developed an economic simulation of what – everything else being equal – the rough diamond price would be today if there were no synthetics. The “normal price” of rough would have been 2-3% higher today. By 2020, we expect, the natural rough diamond price would be some 15-20% higher if there were no synthetics on the market.
Undoubtedly, the producers have also made these or similar calculations. Porter says that faced with a substitute, oligopolistic partners – almost as a Pavlovian type of reaction – will join forces and cooperate to fight a common threat. Even the Russians signed up, apparently having overcome their anger when De Beers unilaterally decided to terminate its purchases from them (something Alrosa contested before the E.U. competition authorities and in court).
I accept producer assurances that the DPA may not have been created because of synthetics – and that category promotion is its main driver. But that doesn’t change the fact that the producers themselves are under threat; their rough placing power with manufacturers (sightholders) may gradually erode. That’s also one of the reasons – if not the main reason – that producers are now optimizing prices and sales, in a way as if there is no tomorrow. This is because they are no longer sure that by keeping diamonds in the ground, by not selling now, they will reap higher prices in the future.

Click to read addendum: Simulation: Rough Prices without Synthetics

The Tipping Point

One of the industry’s most eloquent U.S. analysts, Ben Janowsky, has identified what he calls “tipping points,” or moments in the market penetration of man-made diamonds (MMD) where players are forced to adapt. Janowsky recently described “some indisputable facts about where we are today. Production of MMD’s continues to ramp up. I have long stated that a good percentage of the consuming public will have no problem in buying MMD’s, and that appears to be proving true,” he writes.
“Retailers today are beginning to use MMD’s as alternative lower-priced ‘diamonds’.The machinery is improving, and the cost of equipment is declining. It now only takes about 18 months or less to fully amortize the cost of a [synthetic diamond growing] machine, and we can only expect costs to decline even further. At the present cost differential between naturals and MMD’s, which can be 30-40%, retailers can hit much more attractive price points while improving margin. That alone will become an increasingly significant factor, especially for so many retailers that are located in areas that have not seen real improvement in the economy,” says the U.S.-based industry expert.
What must be realized today is that the miners’ contemplated action is probably too little – and much too late. Large U.S. jewelry chains – such as the 73-store Rogers & Hollands, the 234-store Helzberg Diamonds, 621-store Sam’s Club Members, and the 14-store Robbins Brothers – have already added man-made diamonds to their sales collections. Others will undoubtedly follow.  The largest man-made gem quality diamond distributor, Pure Grown Diamonds in the United States, is reportedly already supplying to some 30 stores.
Gem quality synthetics are sold through showrooms of Brilliant Earth in California, sold through internet retailers such as Numined Diamonds (located in Chicago), by Lorna Davison Designs (in New Jersey) and several additional outlets in Europe and India. Sure, probably only a few stores within these large chains will presently carry the synthetic goods – that’s a volume availability issue. But the acceptability threshold has been passed. It has always been argued that if the large prestigious stores carry synthetics, the speed of market penetration is only limited by lack of supplies. And as Janowsky pointed out, “supplies are ramping up.”
Some of these stores are still wary about cannibalizing their natural diamond sales – and a few say that they are just “test marketing”. The challenge in synthetic diamonds has rapidly become a matter of sourcing – and just like in natural diamonds, not all sources are alike. At this point in time, we believe that man-made diamonds (both disclosed and undisclosed) represent somewhere between 2-4% of the polished diamond supplies (by value). What we have said a year ago at an Indian conference: from a technological perspective, we are currently on the eve of mass-production capacity.

Producer Arguments Failed the Test of Reality

The producers have argued that as long as there is “detection equipment,” the consumer will always prefer the natural diamond. Over the years, I have never seen evidence that this is indeed the case. It is still argued – as RBC analyst Des Kilalea did this week in a note to investors – that “large stones (generally certified) and diamonds set in wedding jewellery or the like will not be vulnerable to man-made stones; it will be smaller goods. This is where efforts at disclosure need to be increased.”
However, during a visit that my colleague Pranay Narvekar and I made to the (then Greenville, S.C.-located) D’Nea man-made diamond jewelry store, it was shown that virtually 100% of sales were for engagement or wedding jewelry. Whether this finding based on one outlet has statistical validity is arguable – but it would be wise not to blindly proliferate the “concept” that synthetics are not for emotional jewelry.

Impact on Producer Strategies

In Botswana and elsewhere, some large mines are entering into their final years of their productive lives. In the past, when a cartel assured continued and consistent rough price appreciation, it was often considered “prudent policy” to leave goods in the ground (or in stockpiles above the ground) to be sold later at a higher price – sufficiently high to compensate for the delayed sales. Here is where synthetics again become a factor.
Miners must ask themselves whether withholding goods from the market – and even creating artificial shortages to push rough prices up – is still the right policy when there is a synthetic substitute available to meet the needs of their clients. Will the synthetics force a lowering of rough prices? Will curtailing mining production eventually trigger diminishing returns on the diamond resource?
The best kind of business to be in, says Porter, is one in which the entry barrier is high and the exit barriers are low. This make it difficult for competitors to come in, and when profits are eroding, it would be easy to exit. In diamond mining, entry barriers have become quite high – but exiting also comes at a price. In some instances, they are so enormous, that it pays to remain in business on a care and maintenance level.
However, to become a gem-quality synthetic producer, entry barriers are lowered by the day. The threat to the diamond producers is real. The entry of synthetic diamonds as a substitute for the natural product is a classic textbook example where an oligopoly, which by definition enjoys the highest profit margins only second to pure cartels, will seek collective industry action. The DPA creation is the logical answer when faced with the threat of substitutes.

Category Promotions to Fight Synthetics

Rio Tinto’s Diamond Manager Jean-Marc Lieberherr, commenting on the current DPA situation says, “the reality is that the only way out of the deadlock is through polished prices rising again and the miners injecting manufacturing margins.” This is very much a mantra of the past: diamond-manufacturing margins will improve if we get polished prices up.
With due respect, as we said already, the industry no longer believes that. The oligopolistic producers, by their own conduct, have demonstrated that whenever polished prices go up, the rough will follow – if the price rise did not precede the polished increases to begin with.
The DPA’s stated objective of category promotion – a very noble and necessary idea – may only pay off in the long term, if it will pay off at all. De Beers’ Vice President, Stephen Lussier, undoubtedly the unrivalled in-house promotion guru, recently suggested to retailers “to step-back from talking about ‘price’ until the story of the diamond is clear. What makes consumers buy diamonds is not the product and the price, it’s the diamond dream, those emotional messages that make people want to engage in the category in the first place,” he said.
The industry has lost its ability to get customers to buy into the diamond dream. Therefore, it is undoubtedly good advice to tell retailers that they present their customers “with emotional and timeless messages that make diamonds unique.” That sounds great – but Lussier misses a crucial point.
When a customer gets into a retail store, in most cases the shop owner or sales representative will guide their potential clients to those products which give the retailers the best margins; the greatest return on the shop owner’s investments. He or she might even give the same emotional speech – adjusted for synthetics. The cheaper price is a bonus for the buyer – as long as the retailer is the “real winner.” When there is product substitution – price becomes an issue.
But the same is true for the manufacturers and traders. The midstream will go where it gets the greatest returns. This is now fully in the producers’ hands. The midstream realize that profits generated by higher polished prices are quickly absorbed by the producers.
De Beers’ President and CEO, Philippe Mellier, gave a recent speech in Tel Aviv, which was clear and profound – and similar to his other speeches: We producers are here to make the greatest profits for our shareholders, and you manufacturers and traders must do the best thing for your business.

DIB expects that manufacturers and traders will be heeding that advice – but not necessarily in the manner the producers hoped for.

By Chaim Even-Zohar. Reprinted from Diamond Intelligence Briefs by special arrangement.

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