- Rough diamond prices have rebounded strongly in the aftermath of the global financial crisis as global mined production continues to decrease at a compound annual growth rate of 3.7% since 2005.
- The geological requirements for diamond formation have restricted the mined production of rough diamonds to a handful of countries. Canada has geopolitical, regulatory, and infrastructure advantages over other large producers.
- Zimtu Capital expects diamond exploration to rebound in the medium term. However, exploration is not for the faint of heart.
Introduction - All hell for a basement?
Diamonds, crystallised carbon, are the hardest naturally occurring material. The optimal environment for the formation of diamonds requires consistent heat and pressure, which is found beneath stable thick parts of the earth's crust known as cratons. Most primary (non-alluvial or coastal), diamond discoveries are hosted within rock formations older than 2.0 billion years. Diamonds form at depths greater than 160 km below surface, and are brought to the surface through violent volcanic activity that has occurred at various intervals through geologic time. During ascent through the lithosphere (upper mantle and crust), the potentially diamond infused magmas accumulate minerals known as KIMs (kimberlite indicator minerals). Kimberlite, an ultrabasic igneous rock made up of at least 35% olivine, form as their volatile rich magmas cool upon their emplacement into the surface and near-surface environment, commonly in the shape of a pipe or champagne flute, and sometimes in the shape of a champagne coupe (as in Saskatchewan).
Source: Kansas Geological Survey, PIC 16
Kimberlites occurring in the Canadian tundra have been affected by the erosion dynamics of continental glaciers during the period of Pleistocene glaciation, which only receded over the last twenty thousand years. These erosion dynamics have in effect smeared these KIMs hundreds of kilometers from their source kimberlite intrusions, distributing evidence of that source as a "mineral train" of fragments that follows the movement of the ice away from the intrusion. Exploration geologists attempt to delineate and follow the KIMs back to the kimberlite by pattern sampling of soil and till (glacial deposits), and recovering the KIMs by laboratory processing of the samples. Since not all kimberlites are diamond-bearing, geologists refine their searches by analysing the KIM grains for their chemistry, which they then assess using industry standard mineral chemistry plots so as to rank those KIM trains to increase their chances of discovering kimberlites that may host diamonds. Kimberlites tend to occur in "clusters" of intrusions of similar geologic age, with multiple proximate clusters referred to as a kimberlite field. A good primer on kimberlites may be found on the Natural Resources Canada website.
There are many reports that focus in-depth on the chemistry of indicator minerals. However, the simple fact is that the odds of discovering an economic diamond deposit are low, even when kimberlites are being found. Globally, approximately 20% of kimberlites are diamondiferous (i.e. containing some diamonds, including microscopic diamonds that the industry refers to as micro diamonds), with roughly 1% of all kimberlites discovered hosting an economic diamond deposit. The odds in Canada, though still poor, are materially above the world norm. As of 2002, over 50% of kimberlites discovered in Canada were diamondiferous; while Lac de Gras had recorded a prodigious 5% of all kimberlites discovered to host an economic diamond deposit. Clearly, diamond exploration is not for the faint of heart, and presents significant risk for even the most seasoned geologist.
The Strokes - An investment theme takes shape
As a non-geologist, I believe there are five important concepts for evaluating diamond exploration and development companies:
- Clusters within a district - such as the Lac de Gras and Kennady Lake clusters in Canada's Slave Craton district in the Northwest Territories - are likely to have comparable indicator mineral chemistries: however, the chemical signature of each cluster, and indeed each kimberlite, is generally unique.
- Kimberlite pipes may, or may not, as is often the case, be diamondiferous. Rapidly assessing the potential of a cluster of kimberlites, once discovered, is essential for go/no-go decisions to be made.
- One carat is equivalent to one-fifth of a gram. Few diamond mines exceed one carat per tonne (kimberlite host mines range from 0.1 carats per tonne to 3+ carats per tonne, meaning that most kimberlites contain less than 1 gram per tonne, on average, of commercial-sized diamonds! The presence of diamonds does not necessarily mean the deposit is economically viable: the combination of grade with average quality of the contained diamonds, and the presence of some larger-sized (coarser) diamonds (the "size frequency distribution" in trade parlance) must conspire to imbue the host kimberlite with a diamond population that merits mining. Assessing the ultimate value of potential diamond "ore" is an exacting process. The commercial failure of the Jericho Project/Mine in Nunavut is a case in point.
- Individual diamonds are unique, as a carat value depends on the size, shape, colour, and quality. This complexity adds an additional economic variable, in contrast to homogeneous commodities such as copper. Said differently, a one carat diamond from Ekati may command a different price than a one carat diamond from Diavik. Grade (carats per tonne), quality (USD per carat), average diamond size (carats), and mineable ore tonnage are all material variables impacting revenue potential, capital requirements, and operating expenditures.
- An advantage of high-grade deposits is that assessing their economic potential is substantially more cost-effective to achieve: specifically, the assessment of grade distribution can be made using smaller drill diameters (for example, if a geologist determined that a 20cm diameter drill would suffice for a 3 carat per tonne "mini-bulk" grade sampling program, he would need a 1.1m diameter drill to accomplish comparable diamond recovery, were the grade to be estimated at 0.1 carats per tonne); similarly, to recover a parcel of (say) 10,000 carats to facilitate an estimate of the average diamond price, a 3,400-tonne "bulk sample" would suffice for the 3 carat per tonne kimberlite pipe, whilst 100,000 tonnes would be needed from a 0.1 carat per tonne kimberlite.
(click to enlarge)
Source: I. Graham and T. Nowicki, Rio Tinto Mineral Services
The quoted size of the global rough diamond market in any given year will vary slightly, depending on the estimate. For example, in 2012, the Kimberly process recorded a market value of U$12.6 billion, while Bain & Company Inc. estimated revenues at U$14.8 billion. There exist significant barriers to entry in diamond mining. In fact, only four large players control approximately 80% of global rough diamond production. It is difficult to access detailed market data, as ALROSA, De Beers, Rio Tinto, and Dominion Diamond treat this information as proprietary. Despite this, there is a compelling narrative for diamond explorers, as ore production from several historically significant mines has stopped (Mir) or is falling (Argyle). Additionally, Bain & Company reports profit margins for rough diamond production has remained healthy at between 16%-20%. The firm also expects demand to achieve a robust compound annual growth rate (CAGR) of 5.1% through 2012 to 2023. This combination of factors should help diamond exploration investment in Canada rebound from C$78.9 million in 2012, which was a contraction of 14% from 2011.
Historical Context - Few players and barriers to entry
Prior to 1870, diamonds were found exclusively in alluvial deposits, primarily from India. However, in 1867, diamonds were discovered in kimberlite pipes located near the town of Kimberley, South Africa; and by 1887, De Beers exercised monopoly control over the global industry that remained unrivaled for nearly 100 years. Mining from pipes has led to the exponential increase in the annual global market supply of diamonds from less than 1 million carats in 1870 to a peak of 176.7 million carats in 2005. Advancements in geological understanding, combined with new mining technology (machines) opened the industrial market for diamonds. However, due to advancements in synthetic diamond manufacturing, mined production of boart (industrial diamonds) could be considered as a by-product that is inconsequential to the economics of diamond mining.
Throughout 1870 to 1960, Africa was responsible for nearly 100% of global production, and many experts believed economic diamond deposits did not exist in Canada. Russia's Mir Mine in Siberia, which started production in 1957, likely helped changed this perception; as well as, Australia's Argyle Mine. Commercial production at Argyle began in 1986, and at its peak in 1994, Argyle accounted for nearly 40% of global annual production as measured by weight.
In contrast, Canada is a relative newcomer on the global stage for rough diamonds. Academic propositions for diamond deposits in Canada began around the turn of the 20th century; yet, exploration did not begin in in earnest until 1960, and it would take the better part of 20 years to refine exploration techniques using an understanding of glaciation and chemistry. Canada likely represented a steep learning curve for even the heavyweight foreign diamond miners. Successful diamond exploration in northern Canada was materially challenged by several factors, including:
- Geography - Numerous lakes, tundra, permafrost, etc.
- Climate - Especially extremely cold winter temperatures, reduced daylight hours, ice road accessibility
- Remoteness - Insufficient infrastructure of roads, electricity, and people; established diamond miners also were dubious of the potential existence of pipes with adequate grade - value characteristics to support commercial exploitation
- Geology - Undeveloped technical understanding regarding the application of glacial drift and eskers prospecting to permit the application of regional diamond KIM techniques
These challenges would take some time to overcome and adapt to. However, for Lac de Gras, home to the world-class Ekati and Diavik mines, diamond-bearing pipes were discovered in 1991. Production from Canada's first diamond mine - the Ekati - commenced in 1998, with the Panda pipe being the fourth-most valuable in the world.
Material mine production from Russia, Australia, and eventually Canada, and a bout of persistent high inflation in Israel during the 1970s all contributed to the eventual demise of the De Beers cartel. Russia is now the global leader of mined diamond production by total carat weight produced.
Source: A. J. A. (Bram) Jamse
The GFC - Value perseveres as output falters
Global annual mine production has materially fallen from approximately 177 million carats in 2005 to only 130 million carats in 2013 (Chart 1). The global annual decline was partly offset by a significant increase in production from Zimbabwe. However, Zimbabwe production fell in 2013 to 10.4 million from 12.1 million carats a year earlier, and expectations for 2014 project an additional decrease in supply. Interestingly, the value of the global diamond market, measured in USD, has remained on an upward, though volatile trend throughout 2004 and 2013, with an average and median annual value of U$11.9 and U$12.0 billion, respectively. The outlier in the population set was 2009, which saw the market for rough diamonds collapse to U$8.3 billion in the aftermath of the global financial crisis; though the recovery was swift and sustained, reaching U$14.1 billion in 2013. Gem-quality diamonds represent only 20%-25% of total annual mined output by weight, yet account for the majority of the value.
Price Growth - The song remains the same
De Beers' marketing is responsible for arguably one of the greatest market creations in the history of capitalism, summed up in one simple slogan - "A Diamond Is Forever". The US has consistently been the largest consumer (Chart 2), though Canada in 2000 led the US on a per capita basis.7 In North America, approximately 70%-80% of women own at least one piece of diamond jewellery. Nicky Oppenheimer, former De Beers deputy chairman, once famously stated, "A gemstone is the ultimate luxury product. It has no material use." As there is no more intrinsic value for gem-sized diamonds over their industrial counterparts, the exponential price increase would seem somewhat peculiar. Therefore, the price of gem-quality diamonds depends not on the diamonds themselves, but on the value bestowed by buyers, or perhaps "captured" by the jewelry industry.
In this light, gem-quality diamond prices hinge on three material variables:
1. Discretionary income growth - Global growth remains positive, albeit more modest than the recent past, indicating a positive long-run trend for discretionary incomes. As of 2012, the Americas represent 37% of global retail demand, while China - the most important market for near-term future demand growth - was 11%. The Americas proportion of world demand should continue to shrink as long as China continues to grow the ranks of their upper-middle class (Table 1).
Source: International Monetary Fund
2. Supply - Falling ore production from several major diamond mines should mean continued global supply constraint and higher prices, all else being equal (Table 2). Since 1870, records indicate there have been roughly 30 large, successful operating mines globally. As previously indicated, the economics of diamond mining depends on much more than the mere occurrence of diamond.
Source: Diamond Dominion Corp. 2014 Annual Report and ZC estimates
3. Cultural - Continued adoption and integration of "western" values, such as diamond engagement rings, in emerging markets with large populations should continue to propel industry growth (Chart 2). A good example is the success of De Beers Diamond Jewellers, an ongoing joint venture between De Beers and LVMH Moet Hennessy Louis Vuitton. LVMH reported its largest market for watches and jewelry in 2013 was Asia (excluding Japan), which represented 27% of total revenue.
Source: Louis Perron, Natural Resources Canada
It is this author's expectation that price volatility will reflect global economic trends going forward. Until 2000, De Beers used its Central Selling Organisation (CSO) - essentially a clearing house for global trade - to control diamond prices. De Beers no longer directly acts in this capacity, and in the absence of a buyer of last resort, the weighted average prices of rough diamonds should be expected to remain volatile, as global uncertainty remains.
Diamond Exploration - Why Canada?
The proportion of gem-quality diamonds tend to be quite pronounced in alluvial deposits, whereas the primary source kimberlite pipes tend to have a wider range of qualities, including a significant share of micro and industrial diamonds. However, with the majority of industrial diamonds being synthetic, new diamond deposits need to contain sufficient quantities of gem- and near-gem quality diamonds to be considered economic; specifically, a significant tonnage with relative high diamond concentration. This is where Canada has found a niche position.
Source: Kimberley Process
In 2013, Canada was a distant fifth-largest producer of diamonds by weight (Table 3), yet third by value (Table 4). Currently, diamond production in Canada comes from 4 mines: Ekati, Diavik, and Snap Lake are all located in the Northwest Territories (NWT); and Victor in Northern Ontario.
Source: Kimberley Process
Clearly, Lac de Gras in the NWT is the standout among Canadian production centers. Diamond-bearing kimberlites in this district are of relatively small tonnage by world standards, yet present as high-grade deposits. The combination of improved understanding of the regional glacial geology and distributions of KIM mineral trains and their chemistry is creating a positive environment for junior exploration to discover potentially high-grade pipes with adequate tonnage. Infrastructure continues to be developed, while existing processing capacity will require ore in the future. The potential to find high-grade deposits may provide discoveries that prove easier to define and are more cost-effective to evaluate.
Source: H. Faulk and K. Gochnauer, NWT Geoscience Office
There are no universally available statistics related to the odds of successfully intersecting kimberlite per drill attempt; however, several Canadian diamond experts have suggested to me that the odds for an experienced, well-funded team operating in a familiar environment could be approaching 50%.
Importantly, Canada, including the NWT, is widely considered more attractive from both a geopolitical and investment risk perspective, when compared with many other large diamond producing countries. As a foreign investor, how safe is capital investment in Angola? Democratic Republic of Congo? Russia? Canada is one of the few large diamond producers with exploration potential, rule of law, infrastructure, technical expertise, and efficient capital markets.
Owing to the challenging nature of diamond prospecting, the exploration team is the most valuable asset an exploration enterprise possesses. The team needs to have a good understanding of the geology and chemistry of the prospective region, patience, and access to capital. One of the obvious, yet overlooked issues from investors is the need for continued land acquisition while following indicator trains. Sometimes, the prospective land will only be available in the future, if at all.
Gahcho Kué - Demonstrating significant potential
Evaluation of Gahcho Kué diamond-bearing kimberlites began in 1995, and is currently advancing through the regulatory process. Gahcho Kué is a joint venture between De Beers Canada Inc. and Mountain Province Diamonds Inc., and is located at Kennady Lake, in the southeast of the Slave Craton, approximately 150 km southeast of the Ekati and Diavik mines and 80 km east of Snap Lake in the NWT.
The Gahcho Kué project consists of four diamond-bearing kimberlites, with an aggregate resource estimate of 33.8 million tonnes of ore containing 56.5 million carats yielding a grade of 1.67 carats per tonne indicated, and an additional 11.3 million tonnes of ore containing 18.5 million carats inferred.
Zimtu believes interest is returning to diamonds. Canada, with increasing rough diamond prices, improved glacial understanding, and advancements in exploration techniques should attract investment for diamond exploration. Though not all-inclusive, we have attached a list of US and Canadian publicly traded diamond companies (Table 5).
Source: Stockwatch and Company websites
The inherent risks associated with diamond exploration and development can be a significant hurdle to overcome for potential investors. Arguably, diamond prospecting is the most challenging form of exploration; and even when diamonds are found, there is no guarantee of success. In fact, most diamond explorers have market values below $10 million. However, as can be seen from the table above, market capitalisation increases substantially as risk diminishes. All else being equal, this demonstrates a significant risk-reward trade-off.
For these reasons, potential investors comfortable making high-risk investments into diamond exploration should focus on risk minimization rather than return maximization. In general, there should be a bias toward:
- Diversification - both within the industry, from exploration to production, and at the company level
- Geography - districts that contain proven economic diamond deposits may host potential clusters of diamond-bearing kimberlite, and existing infrastructure
- Geopolitical risk - much of the global mined diamond production comes from nations that carry substantial market risk.
- Experienced exploration teams - that have a strong technical and financial background.
Investing in a basket of companies (production, development projects, and exploration), operating in prospective regions with existing production, and strong technical backgrounds could capture upside diamond price movements as demand continues to grow in developing Asia. As always, potential investors are advised to consult their financial advisor first.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.