We all know that first-half 2007 sales have been slow. The government reported a paltry 0.5 percent growth over 2006. Considering that gold and diamond prices are up, we also know that means a real dip in unit sales.

It would be easy to blame the poor performance on a stressed economy, and the likely downturn we’ll see in the coming months. That may be true, but it avoids greater underlying problems for many U.S. jewelers, with survival at stake.

The diamond business has evolved over 30 years into the bedrock on which many retail businesses rest. A portion of that, from 0.25 cts. and up, has seen significant erosion in profit margins, in good part because of the rapid growth in Internet sales. With cut grading becoming common, price competition will become fiercer. Even if a sale ends up being made at the retail counter, the Internet has become the de facto price list for graded stones. If futures trading (as is now being proposed) becomes a reality, prices will become the equivalent of looking up a stock on the Nasdaq.

The loss of margin in this critical area has slimmed profits to the point where cash flow is used for operating costs instead of paying vendors. That means curtailing buying, which can begin an unstoppable downward spiral. Retailers may lean more on suppliers for terms and memo, but unless inventory turn is increased, that is a dead end, too.

Unit sales may be affected (as they are this year) by increasing prices on precious metals. The public will adapt to jewelry using silver, steel, palladium, and titanium. But will retailers do the same? Major gold miners are de-hedging lately (Newmont de-hedged entirely), which means they’re confident gold is going in only one direction: up. These companies see weakness in the dollar for the next few years, and with metals and diamonds dollar denominated, that means higher prices for everything. So, every retailer needs to develop scenarios to deal with gold going to $1,000 and higher and better-diamond prices holding their high levels or going higher.

The continuing 20-year decline in the number of U.S retailers doesn’t spell the end of jewelry retailing. Instead, it shows a process whereby the business is becoming more segmented. Mall chains and discounters have captured the low-end market and a good part of the mid-market. Specialty stores and wholesale clubs have captured a good part of the mid-market and the upper market. The Internet has captured a good part of the price-conscious buying public.

It is the independent retail channel that is most diverse in response to market trends. Stores located in very affluent neighborhoods continue to accrue business, as incomes for the rich have risen. They have become, in a sense, diamond destinations. Others stress fashion and designer lines.

But many independents are floundering. Few have accepted that the future means differentiation, a robust online presence, superior services, and close relationships with the right suppliers.