Fewer carats good for long term vision at gem supplier

De Beers, with its virtual monopoly on the world diamond market, knows what it is talking about when it warns of a shortage of precious stones. It may well be responsible for it

A 5.16-carat pear-shaped internally flawless vivid blue diamond ring, which was formerly in the De Beers millennium jewels collection.

De Beers, the world's largest gem supplier, says diamonds are running out. Therefore, the company has no choice but to cut production and save its dwindling reserves. The words De Beers, diamonds and shortage belong together in a sentence in the same way "pinch" is often followed closely by "salt".

It's not that De Beers is being dishonest; far from it. Diamond dealing is one of the last remaining businesses where deals are still concluded with nothing more than a handshake. If, as the Financial Times recently reported, De Beers says there will be a shortage of diamonds, believe it. Few companies enjoy such insight into their market as not many enjoy such absolute control over it. Without de Beers there would be no diamond industry. Diamonds are neither particularly rare nor are they hard to find, something De Beers has understood since it was founded on a dusty African plain more than 100 years ago.

By an accident of technology the company very nearly destroyed itself within a few years of its establishment in 1888. It was founded by the arch-imperialist Cecil John Rhodes who arrived in the middle of the Kimberley diamond rush to the sight of thousands of sweating prospectors scrambling over a hill atop an ancient volcanic pipe that spewed a fabulous amount of diamonds. Rhodes bought out the diggers and introduced the latest deep-level mining techniques to follow the diamond pipe into the earth.

The problem was all these gems pouring out of the mine brought with it a threat of swamping the market and collapsing the price. Rhodes saw that soon every Tom, Dick and Harriet would be wearing diamonds as affordable costume baubles and his newly formed company De Beers would go bust. His response was to hold back supply and begin a stockpile of excess rocks that De Beers has maintained and increased ever since, at times reaching as much as US$5 billion (Dh18.36bn) in value.

This allowed the company to artificially prop up the price of diamonds and maintain the fiction that they were a scarce commodity. For more than 100 years, De Beers has held near absolute control over the movement, classification and valuation of diamonds. Uncle Sam has been involved in antitrust litigation in one form or another against the company since the Second World War, and it is only recently that De Beers, after paying hundreds of millions of dollars in penalties, has been allowed to legally operate in the US.

De Beers recognised early that if it wanted to create long-lived desirability it needed to look beyond the dwindling number of princes and pashas who bought the stones. It had to find a way to sell to the masses without devaluing the product. As a result, in the 1940s it began one of the most successful advertising campaigns of all time. Its Madison Avenue spin doctors figured that there was one event no young man could avoid: marriage.

Using the slogan "diamonds are forever", De Beers manufactured the tradition of the engagement ring. As a result, hardly a wedding takes place anywhere in the world without adding to De Beers's bottom line. Today, De Beers appears a kinder, gentler creature. It is a firm supporter of the Kimberley Process, which tries to guarantee that no conflict diamonds - rough diamonds used by African rebel movements to finance wars against legitimate governments - end up gracing the fingers of a young starlet.

The company is a subsidiary of the respectable FTSE member Anglo American. It sells $32bn in stones through Dubai each year, according to Bloomberg, and its web of production reaches Israel, India and New York. Recent activities suggest De Beers may still be manipulating an artificial shortage of stones to support the diamond price. It recently gutted its exploration department and retrenched most of its geologists in a signal, some suggest, that the company plans a long-term easing of production. It has also closed less productive mines and sold others.

De Beers has held on to more lucrative assets, such as the low-cost producer Jwaneng in Botswana. But it seems clear it foresees in the long term that fewer diamonds coming out of the ground will translate into more dollars in its bank account. [e-mail]