THE diamond sector is going through a consolidation period with rough diamond prices expected to pull back between 5% and 10%, according to RBC Capital Markets analyst Des Kilalea.

Reviewing recent trading and management statements released by three diamond miners - Petra Diamonds (Petra), Gem Diamonds (Gem) and Namakwa Diamonds (Namakwa) - Kilalea said Petra remained RBC’s “favoured exposure”.

He said: “Gem’s investment thesis is leverage to diamond prices until such time as a growth strategy emerges. While Gem’s aim of cutting/polishing selected rough may boost returns, it is unlikely, in our opinion, to materially boost growth.

“We prefer Petra which has growth.”

Turning to Namakwa, Kilalea said: “The interim management statement offers indications of success in Lesotho and the Democratic Republic of Congo.

“Much still needs to be done before these projects will change the investment case for Namakwa, in our view. Short-term risks are mostly in a nervous rough diamond market at present, where prices appear to contain some speculative froth.”

Kilalea said many in the diamond cutting centres were expecting prices to pull back 5% to 10% because of “still sluggish jewellery sales in the United States, Europe and Japan and indications of some slowing in demand growth in China”.

Said Kilalea: “While supply of rough is still tightish, leading producers are selling more and the Russian State Treasury – the Gokhran – has suggested it may sell into a ‘speculative’ market.

“In addition, many fear that the granting of limited Kimberley Process certification to Zimbabwe rough could see a flood of diamonds undermining the lower end of the market.

“Exactly how Zimbabwe will play out is unclear given EU (European Union) sanctions and US restrictions on certain Zimbabwean organisations connected to the Marange diamond field.”

The trading update released by Petra on Tuesday said the company anticipated “some consolidation in the market” but was upbeat about prospects for the end of the year.

Petra CEO Johan Dippenaar said: “There are expectations of a significantly improved year-end, driven by the traditionally strong festive buying season (Thanksgiving and Christmas).

“Exciting demand growth continues at double digit pace from China and India, with market commentators predicting that China could grow to equal the US diamond market within the next decade.”

Dippenaar added that “global diamond supply will be higher this year than in 2009, due to increased sales from De Beers and Alrosa”.

He said: “However, it is still anticipated that supply constraints will result in a significant shortfall to the market which will emerge in the next three to five years.

“New sources of production coming on stream in this timeframe will only serve to temporarily counteract the depletion of the world’s largest diamond mines, which are all past their peak and can no longer be operated at previous higher levels of production.”

Kilalea said: “The trading statement should dispel worries about Petra’s growth projects. Share price weakness is, we believe, driven by understandable nervousness about global growth including the fast-growing Chinese market.

“We believe Petra remains a core holding in a sector where future supply shortage should underpin rough prices in the medium term.”