Overview
The diamond mining industry now effectively operates as an open market, following decades under a cartel situation with De Beers. This transformation has had a positive effect and not caused the price volatility or collapse that was feared by some. We have in fact witnessed a strong market based on perceived consumption-growth outstripping demand-growth, with little recycling because of the structure of the diamond retail system. Established diamond markets in the USA and the rest of the developed world are expected to remain steady, although they could be vulnerable to any economic downturn, but demand growth from developing areas is expected to continue to cause tight markets, something that should be reflected in an uptrend in diamond prices. Estimates show a volume growth in demand of around 6% per year (WWW International) which assumes continued growth in China, and relatively steady off-take in the US and other leading western economies.

Although De Beers is now effectively private, with the only public equity exposure through 45% holder Anglo American, the group retains a significant influence on the market in several ways. De Beers is still the largest diamond producer, and although it no longer controls the market, the sales division is still the largest marketer of rough stones. In addition, many current exploration projects and new/reactivated operations are on tenements formerly owned by De Beers, which often retains an interest. It has also been the breeding ground for diamond company executives and staff.

Boosted by new technology, diamond exploration activity has undergone resurgence in recent years. However, it is evident that junior companies, often funded by majors, are effectively driving exploration and development activities worldwide. Despite this, the number of major deposits discovered over recent years appears unlikely to satisfy growing demand (Exhibit 1).

Exhibit 1: Number of kimberlites discovered per year, as a five year moving average.

Global production is dominated by less than twenty major mines controlled by only four mining groups, with major mines shown below in Exhibit 2.

		De Beers has primary kimberlite mines (Venetia, Finsch, Premier), together with alluvial beach and offshore operations (Namaqualand) in South Africa, major joint ventures with the Governments of Botswana (Jwaneng, Orapa, Letlhakane mines), Namibia (Namdeb) and Tanzania (Williamson), operations in Canada, and numerous joint ventures worldwide.
		Alrosa controls the Russian diamond mining industry (Jubilee etc.), and the Catoca mine in Angola, and is considering a public listing.
		Rio Tinto has the Argyle mine in Western Australia, the Diavik mine in Canada and Murowa in Zimbabwe;
		BHP Billiton, has 80% of the Ekati mine in Canada, and is involved in several joint ventures.

Exhibit 2: World diamond occurrences.

Geology
The high risk element of diamond exploration is primarily a reflection of the geology which hosts the product. Unlike metal deposits, which often have large low-grade 'aureoles' to aid discovery, diamonds form in relatively small pipes which leave their surrounding host rocks untouched. These pipes, called kimberlite or lamproite, are generated in a specific geological region, known as the diamond stability field, between the earth's crust and the mantle some 150km - 200km beneath the surface. Pipes come to the surface rapidly in a gas-driven surge, effectively forming a non-molten volcanic explosion underlain by the residual near vertical feeder pipe and narrow horizontal intrusions called fissures.

The largest primary deposits are in Southern Africa, Russia, Canada and Australia. Erosion is part of the cycle of continent building and destruction, where the primary pipe erodes to form secondary ?placer? diamond deposits in rivers or near land ocean platforms that mark former levels of the sea. Because diamonds are hard and chemically-resistant, they can survive a number of cycles of erosion and can be concentrated downstream of the primary deposits. The main economic considerations for alluvial deposits are twofold:

1. per carat value is usually high, as there is a larger proportion of large stones;
2. grade is notoriously difficult to quantify, changing dramatically from layer to layer in preserved river gravels and offshore deposits.

Exploration and Development
With the exception of deposits with a surface expression, exploration for kimberlites was, historically, a long, arduous and frequently fruitless task. It generally led from the discovery of an alluvial source and tracking the primary source of the diamonds through panning techniques (Exhibit 3). Frequently, the primary source could not be located as it may have been largely eroded or buried by subsequent
sedimentary deposits.

Exhibit 3: Typical diamond exploration value chain.

Indicator mineral analysis (Exhibit 3, Stage 1) has become a very successful method whereby microdiamonds
and more abundant heavy minerals associated with diamonds such as garnet and ilmenite, are identified in regional soil sampling, and then traced to the primary source with follow-up sampling or geophysics. There have been major advances both in the detection of kimberlites and determination of potential diamondiferous content (Exhibit 3, Stage 2). Modern exploration techniques have significantly increased the likelihood of detecting host rocks by geochemical and geophysical surveying. Geophysical systems include methods such as the De Beers gravity zeppelin and Falcon^TM airborne gravity system that can detect these anomalies under sediment cover. Modern exploration techniques (Exhibit 3, Stage 2) have impacted the exploration industry in that although such techniques have improved, they come at a high cost, and are often the domain of well funded or joint-ventured junior and mid-cap explorers. This means that junior mining companies are commonly restricted to soil sampling to identify micro-diamonds and indicator minerals associated with diamonds, which is a lengthy process, while mid-cap or more mature explorers often JV with larger companies to access larger exploration budgets and more high-tech tools.

Better recovery in testing potentially economic pipes (Exhibit 3, Stage 3) has resulted in identification of economic grade where historically pipes were deemed sub-economic. This has resulted in pipes previously identified as sub-economic being re-sampled and proving to be worthy of mining, with the best example being the AK6 pipe, jointly developed by De Beers and African Diamonds. However, because diamonds are in such low grade in kimberlites, and diamond value is strongly skewed by very rare high-value stones, sampling with expensive large diameter (16"-23") drilling and test-pits is required to define a JORC compliant resource, followed by lengthy ore processing to recover all diamonds to ascertain an average value.

Considering this value chain, it is important to remember that fewer than 4,000 kimberlites have been identified globally, only 10% of those contain diamonds at all, and only around a third of those are economic (Exhibit 4). It must also be realised that time-scale to development is commonly very long (Exhibit 5), predominantly based on evaluation of the grade and tonnage of pipes.

Exhibit 4: Number of diamondiferous and economic kimberlites as a portion of total.

Exhibit 5: Typical time to bring diamond deposits into production.

Mining Economics
This is a complex area as economics are controlled by more factors than metals which can be related to a single terminal price. Diamonds are valued according to the four 'Cs': carat, colour, clarity and cut, and as a result have multiple categories for pricing. Grade, tonnage and costs are the other significant factors, while political risk is particularly sensitive due to the location of many geologically favourable zones in Africa.

Revenues are a combined function of grade and carat value. Grades are usually measured in carats per hundred tonnes (cpht) or carats per cubic metre for alluvial deposits, where specific gravity (weight of a cubic meter of 'ore') can range from 1.2 for sands to 2.6 for quartz gravels. Grades range from 0.5cpht for large alluvial operations such as Schmitsdrift in South Africa, to 170cpht for the Argyle lamproite in Australia. Average values in primary deposits range from US$10/ct for Argyle to over US$1,000/ct for Letseng in Leshoto. Alluvial deposits typically have high average diamond values as large high value stones survive erosion better. The value of individual stones can rise exponentially with size and quality.

Exhibit 6: Diamond value by deposit; contours show US$/t, which is a function of grade and carat value per stone.

Kimberlite pipes are typically mined from surface open pits initially, moving to underground mining at later stages if the depth extensions support it. Development of alluvial deposits is more typically done in open-pit, strip mining, dredging, beach operations, or marine extraction, with each method having a very different cost structure. The erratic grade and value of diamonds in alluvial deposits makes these large volume operations extremely price margin sensitive, with mining companies often being forced to move from bulk sampling into mining seamlessly based on the difficulties of assessing grade and value.

Treatment procedures for diamonds are relatively simple compared with metal processing plants, and therefore generally low cost, as they depend primarily on specific gravity differentials. Some modern dense media separation (DMS) and sophisticated final sorting equipment that uses x-ray fluorescence can be relatively expensive but this is compensated by higher efficiencies.

Supply and Demand
Global annual supply of mined diamonds is currently around 175 million carats (Mct) valued around US$13bn, and only eight countries account for 94% of global production (Exhibit 7). Demand is dominated by the US, but Asian demand is growing rapidly (Exhibit 8).

Exhibit 7: Diamond supply (2005)

Exhibit 8: Rough diamonds demand by country (2006)

Around 40% of natural diamonds are classified as industrial quality and are mainly used in facing cutters and abrasives as the size, colour and clarity is sub-standard.

Despite the high value of diamonds, only limited substitution has occurred in the gemstone market. Commercial production of synthetic diamonds uses graphite subjected to intense heat and pressure, emulating conditions found within the diamond stability field. Synthetic diamonds, claimed to be indistinguishable natural diamonds, may prove acceptable from some consumers on the grounds of lower cost, but appear unlikely to make a significant impact on the natural diamond market.

The influence of conflict diamonds concerns has been largely offset by Kimberley Process Certification Scheme (KPCS) which appears to be close to attaining participation from all producers.

Importantly, given the long time frame to bring a new discovery into production, it is possible to forecast maximum global supply for the next 5-7 years reasonably reliably. The net effect of the supply / demand is shown in Exhibit 8, where, if demand growth continues at current rates, it can be seen that a clear imbalance is likely to occur, which would force prices up and lower demand as a result.

Exhibit 9: Supply / demand balance for diamonds.

Pricing
The value of a diamond is determined by its weight in carats, its colour, clarity, and finally its cut, colloquially known as the four Cs. Larger diamonds command disproportionably higher prices, with 7% of global diamond production by weight accounting for 46% by value. Although diamonds form a variety of colours, yellow is the dominant influence. The colourless grade is generally the most valuable, but some colours can fluctuate in value due to chances in fashion and can be designated 'fancy'. Clarity is a measure of imperfections, known as inclusions. Cut is a function of the shape, proportions and finish which determines the 'sparkle', and is a measure of the skills of the cutter.

Demand growth, particularly from developing countries, combined with lower supply growth (Exhibit 9), has led to rising diamond prices and less need for the stabilisation control. De Beers has now relinquished its position as controller of prices and sales through its Central Selling Organisation, becoming 'a supplier of choice', which has led to other mining companies marketing diamonds. Despite this, the continuing supply / demand imbalance has been forecast to lead to diamond prices rising at around 5% per annum for the medium-term future (Exhibit 10).

Exhibit 10: Rough diamond price forecast.