The suggestion that a Canadian junior mining company would one day own a controlling interest in a legendary diamond jeweller would have seemed preposterous a decade ago.

But that is exactly what has happened. Aber Diamond Corp. of Toronto, once a tiny junior with a long shot of finding diamonds, now holds 51% of New York-based Harry Winston Inc.

The Aber story demonstrates just how much the industry has evolved since diamonds were discovered in the Northwest Territories in the early 1990s. Back then, De Beers SA ruled the market. With few exceptions, producers the world over sold their stones to De Beers at a price and quantity determined by the South African giant, then went back to the business of mining.

The discovery of the Ekati and Diavik diamond mines changed everything. Large commodity producers, such as Australia’s BHP Billiton PLC and Britain’s Rio Tinto PLC, weren’t prepared to kowtow to De Beers. They wanted flexibility in their dealings with customers and the chance to move downstream in the market. And they weren’t afraid to use their financial clout to challenge De Beers.

“The biggest change in the diamond market over the past five years or so has been De Beers’ share of the market: it has dropped to less than 50% from two-thirds,” says Neil Buxton of WWW International Diamond Consultants Ltd. of London, a 15-year veteran of De Beers. “The main reason for that is new Canadian production.”

Gone is the De Beers monopoly over rough diamonds, and with it the secrecy surrounding the exploration, mining and marketing of the stones. Gone, too, is De Beers’ role as a manager of supply that controls prices by soaking up excess rough stones when the market is soft and unleashing inventory in good times.

Many industry analysts had assumed that if the De Beers cartel collapsed, diamond prices would come tumbling down as supply flooded the market. But the opposite is happening: diamond producers can’t keep up with demand, resulting in a 40% increase in rough diamond prices since 2001.

And instead of one company controlling supply, there are several competing producers that participate at all levels of the market, from the $US9-billion rough diamond segment to the US$57-billion retail sector. The middleman, once an essential component of the business, is being squeezed out, allowing producers and jewellers alike to realize greater margins on their sales.

The implications for smaller players in the global diamond industry are significant. If they can find retailers to market their production and provide mine financing — a loan or equity position — they have a much greater chance of success.

Aber is a perfect example. In one remarkable decade, the junior has grown from a tiny explorer into a diamond producer with a significant retail interest and the largest market capitalization in the world for a diamond-focused public company.

In the early 1990s, Aber was just another junior trying to find a diamond mine in the Canadian Barren Lands. By 1994. it had discovered diamonds with partner Kennecott Canada Exploration Inc., a division of Rio Tinto; by 2000, the Diavik mine was under construction.

But in order to maintain its 40% interest in Diavik, Aber had to find a way to contribute its share of the $1.3-billion capital cost. The banks weren’t biting, but New York-based jeweller Tiffany & Co. was. In exchange for access to a substantial portion of Aber’s share of production from Diavik, the high-end jewellery retailer made a $100-million equity investment in the junior.

The Aber/Tiffany deal — unique in the diamond business because it channelled rough diamonds from the mine directly to the retailer — was the key that unlocked the bank vault, allowing Aber to tap into development financing that may have been unavailable otherwise.

“The diamond business isn’t like the metals
business; you can’t hedge production or lock in cash flow to secure your loans, because the pricing and value of diamonds is highly variable,” says Peter Gillin, chairman of Tahera Diamond Corp. of Toronto, which recently became the second Canadian miner to sign a marketing agreement with Tiffany for the stones from the Jericho project in Nunavut.

Last year, Aber swam further downstream with the purchase of a 51% stake in luxury jeweller Harry Winston. The deal gives Aber direct access to the retail market and, just as importantly, makes the diamond producer less dependent on Diavik, a depleting asset.

@page_break@Harry Winston is probably best known for the jewellery that adorns celebrities at the Academy Awards ceremony. The average price of a Harry Winston creation is about US$47,000.

“We are linking the two bookends of the industry,” Aber president Robert Gannicott told delegates at a Canadian Institute of Mining & Metallurgy conference in April.
“Retailers struggle to secure supplies of high-quality diamonds, and it’s a strategic benefit to have a reliable supply in a country like Canada.”

Gannicott says the transformation is the result of strategic decisions that ruled out exploration for more mines as too risky (more than $1.8 billion has been spent on exploration in Canada since the Diavik discovery, but no new mine has come onstream yet), and he dismissed the possibility of Aber becoming an income trust because it would have left no money for further capital development at Diavik.

In the fiscal year ended Jan. 31, 2005, Aber had net earnings of $53 million (92¢ per share), vs $28 million (50¢ per share), the previous year as a result of increased production from Diavik and better rough diamond prices. Using this considerable financial muscle, Aber plans to expand the Harry Winston network of stores to more than 40 by 2012 from seven in 2004.

Aber also has an eye open for new sources of feed for its sorting plant in Toronto and, ultimately, its retail stores. But advanced diamond projects in stable countries are rare. “So far, nothing has come up,” says Gannicott.

Tiffany, meanwhile, has secured another source of rough stones by closing a deal with Tahera for production from the Jericho mine in Nunavut. In this case, Tiffany will provide debt financing, buy diamonds that meet the jeweller’s specific standards and take responsibility for marketing the remaining Jericho stones to other customers.

Once again, the producer/retailer partnership solves problems at both ends of the market spectrum: Tiffany gets a reliable supply of rough stones, while Tahera gains the credibility and some of the financing it needs to build Canada’s third diamond mine.

“Tiffany perceives a long-term shortage of high-quality diamond supply, so its strategy is to secure good-quality diamonds at the mine source. That’s why it did the Aber deal and is the principal motive for our deal,” says Tahera’s Gillin.

De Beers is trying to establish its own retail niche in the new marketplace. In late June, De Beers LV — the result of a partnership between De Beers and luxury-goods group Moet Hennessy Louis Vuitton SA of Paris — opened its first retail store in New York.

Just a couple of years ago, that milestone was inconceivable. De Beers was still banned from operating in the U.S. as a result of price-fixing charges dating back to the 1940s. Last year, De Beers paid US$10 million to settle the charges, paving the way for the company to capture a part of the U.S.
retail market, which accounts for more than 50% of diamond jewellery sales.

The company’s 6,000-sq.-ft. store on Fifth Avenue features three main groups of designs ranging up to US$1 million per piece. A second store will open on Rodeo Drive in Los Angeles in November. It’s not a stretch to imagine De Beers will eventually start cutting and polishing its own stones for sale directly to its own stores.

Meanwhile, the market for diamonds continues to brighten because demand is outstripping supply. According to industry watchers, demand is growing at the rate of about one Diavik mine per year (about 3.5%). Supply is dwindling as current mines are depleted. Even the relatively young Ekati and Diavik mines, which together represent about 10% of world supply, are expected to peak by 2008 or 2009.

“Our long-term view of the diamond industry is that there [will be] a shortage of diamonds,” says Buxton. “We don’t see supply outstripping demand because the fundamentals just aren’t there for that.
Unless there is some catastrophe such as 9/11, we don’t see excess supply as being an issue.”

In a market this strong, he says, the trend toward partnerships between retailers and Canadian producers will only accelerate.

“There is shortage of rough [stones], so
jewellers are trying to source their diamonds as close to the mine as they possibly can because it cuts out all the middlemen,” adds Buxton.

“Another reason, from a marketing point of view, is that North American diamonds are an ideal commodity for them to be pushing because they can guarantee that they are untouched by so-called ‘blood’ diamonds.” IE