Rapaport News
Tuesday, Mar 1, 2005
15:20 New York

Making the Cut in Canada

By Duff McDonald Posted: 2/2/2005 10:13 AM

The signs are not good. Just five years after its birth, the diamond
cutting and polishing industry in Canada's Northwest Territories (NWT) is
acting more like an old codger on his last legs than a strapping youth with
a bright future ahead of him. Three out of the four operations have run into
serious financial difficulty. Employment of locals ~W an objective from the
start ~W is thin and turnover is high. And the effort to establish the
definition of a Canadian diamond as one that is mined, cut and polished in
Canada ~W in the hope of providing a marketing advantage to domestic cutters
and polishers ~W has been stopped dead in its tracks.

The latest in a series of stumbling blocks came last June, when the
industry's erstwhile protector ~W the Government of the Northwest Territories
(GNWT) ~W put the two largest diamond cutters ~W Sirius Diamonds and Arslanian
Cutting Works ~W into receivership in order to protect $14 million (CAD$17.2
million) in loan guarantees. While Arslanian was purchased shortly
thereafter by Montreal~Vbased Basal Diamonds and a deal for Sirius was
pending at year-end, both industry and government sources are now openly
pondering whether or not the experiment has failed. "I think it's tough to
even call it a local industry anymore," says Jake Kennedy, the editor of
Canadian Diamonds magazine.

It was an experiment with noble intentions. After the discovery of the Ekati
deposit, the GNWT made explicit its intention to develop a secondary diamond
industry in Yellowknife. And therefore, in 1996, BHP Billiton, owner of the
Ekati mine, signed an agreement to allocate up to 10 percent of its output
to local industry. Diavik Diamond Mines Inc., entered into a similar
agreement in 1999. Through a further combination of grants for training and
acquiring equipment as well as loan guarantees, an industry was born. Sirius
Diamonds opened in June of 1999. Deton'Cho Diamonds and Arslanian Cutting
Works opened in 2000 and Laurelton Diamonds, a wholly owned subsidiary of
Tiffany & Co., opened in 2003. De Beers, which has yet to begin production
at its Snap Lake Project, has also agreed to provide rough diamonds to
manufacturers in the NWT.

How Can Canada Compete?
>>From the start, however, critics have pointed out a glaringly obvious fact:
diamond cutting and polishing is an extremely competitive business, which is
dominated by countries with significantly lower labor costs than in
Yellowknife ~W in particular, India and Russia. The per-carat labor cost of
cutting in Yellowknife is roughly $65 (CAD$80) versus less than $10 (CAD$12)
abroad. How, the critics asked, could facilities in Yellowknife compete
against labor costs about one seventh of their own? There were three
possible answers to this question, not all of which have proven successful.

Answer #1
By creating a Canadian diamond brand, local cutters would be able to sell
their diamonds at a premium that was large enough to account for their added
operating costs. In the late 1990s, this was not necessarily a misguided
assumption. The diamond world was reeling from bad press over conflict
diamonds and the long road toward the Kimberley Process (KP) would not begin
until May of 2000. The GNWT and the cutters themselves pushed hard for a
definition of Canadian diamonds that would include only those that were
mined, cut and polished in Canada.

The effort has not been successful and a November 2001 ruling by Canada's
Competition Bureau that a Canadian diamond need only be one that was mined
in Canada still stands today. "If that had happened, diamond producers would
have ceded any benefit Canadian branding might have to customers that
purchase less than ten of the product," says Robert Boyd, president and
chief executive officer of Ashton Mining. "We're not against seeing
development of a secondary industry in Canada," he continues, "we just don't
want it to be us that has to subsidize it."

Without the theoretically enhanced margins of their own valuable brand,
local cutters have had to compete head on with other cutting centers ~W and
the going has been tough. Deton'Cho did not even last two years before
shutting down briefly in 2002. It re-emerged in 2003 as Canada Dene Diamonds
~W a partnership between the Deton'Cho Corporation and Schachter & Namdar
Polishing Works. That factory, which is said to have turned a $612,200
(CAD$750,000) profit in 2003, has since steered clear of financial
difficulties. Still, in 2003 the original three factories bought only 3.8
percent of available rough from the two mines ~W a third of what is available
to them ~W most likely due to an inability to come up with the cash to
purchase any more.

Answer #2
By automating the cutting process. In other words, the way to compete with
low foreign labor costs might just be to eliminate those labor costs
entirely. One of Canada's most successful cutters is Vancouver~Vbased HRA
Investments Ltd., which operates the only 100 percent robotic diamond
factory in the country. The company's equipment can cut and polish a diamond
in two hours, whereas it takes at least a day for a human to do so.

Might such a strategy work in Yellowknife itself? Perhaps. But replacing man
with machine would effectively eliminate much of the rationale for promoting
the local industry ~W about 150 jobs and $10.6 million (CAD$13 million) in
wages. Ron Basal ~W who paid $7.5 million (CAD$9.2 million) for 75 percent of
Arslanian ~W has stated publicly that he plans to expand the plant, both by
increasing automation and by hiring more employees. If throughput increases
enough to drive labor cost per carat down significantly, such a strategy
just might work.

Answer #3
By not competing at all. One surefire way to avoid losing a head-to-head
competition with foreign cutters is to avoid competing with them, a tactic
that seems to be what Tiffany had in mind when it established Laurelton
Diamonds. Tiffany, which has a deal with Aber Diamond Corporation ~W which
owns 40 percent of Diavik ~W to buy $50 million (CAD$61.2 million) in
diamonds annually for the next nine years, has no interest in whether
Laurelton could cut and polish diamonds and then sell them on the open
market for a profit. Tiffany keeps the diamonds for themselves.

"Everything that we polish that comes out at a Tiffany-quality level we sell
to Tiffany," says Andy Hart, president of Laurelton Diamonds and vice
president of diamonds and gemstones for Tiffany. While Hart acknowledges
that polishing in the NWT is more expensive than other options available to
Tiffany, he adds that Tiffany still shows profits from jewelry made with
Laurelton-procured diamonds.

There is also much talk about what Israeli tycoon Lev Leviev plans to do
with Sirius if his bid ~W which was conditionally approved in September 2004
~W is ultimately approved. It is doubtful that Leviev, who owns cutting
plants in Russia, India, China, South Africa, Ukraine and Armenia, was
attracted purely by the economics of running a cutting plant in Yellowknife.
More likely, say industry insiders, he will use it as a foothold in Canada
to continue his quest to take on De Beers on all fronts. In this scenario,
the profitability of Sirius might be less important to Leviev than its
existence as a Canadian foothold. Again, competition with Indian cutters and
polishers, for example, may not be the primary motivating factor.

The Consensus
In the final analysis, the number of people who think the Canadian cutting
and polishing industry is a failed experiment continues to grow. One
employee of the federal government points out that Arslanian's former owner,
Rosy Blue ~W one of the world's largest manufacturers and distributors of
diamond jewelry ~W could not make a go of it and wonders openly who could.
"They have a humongous marketing ability, but could not make any money in
it. So who can?" he asks. "They didn't walk because they were making too
much money." Canadian Diamonds' Kennedy voices similar sentiments and offers
a bleak prediction, "It's hard to imagine another factory opening in
Yellowknife, but it's not hard at all to imagine one or two shutting down."
However, continued interest in owning the facilities suggests there is still
hope, if a faint one. "With any industry, there are a wide variety of
business models and it takes some time to sort out what the best ones will
be for new endeavors," says Martin Irving, director for diamond projects for
the GNWT. "Look, if they can cut diamonds in Siberia, then they can cut them
in Canada," says Mayer Gniwisch, a Montreal~Vbased diamond expert. Gniwisch,
who once publicly questioned whether Canadian cutting centers can ever
compete with their foreign counterparts, reportedly had a change of heart
last year ~W he was a bidder for Sirius.