Gem Diamonds in merger talks with Lucara

"These discussions are at a very early stage and there can be no certainty the contemplated merger will occur or of the timing or terms of any such transaction," said Gem.

Gem, which is listed on the FTSE 250, is a majority shareholder in the Letseng mine in Lesotho, a long-life, producing kimberlite mine renowned for its high quality diamonds. It also has a 100pc interest in Ellendale lamproite mine in Western Australia, the only reliable producer of highly sought-after yellow fancy diamonds.

The company said in a statement last week that full-year pre-tax profits rose to $54.5m (£33.5m), from $39.2m, as the prices of rough stones increased.

The company forecasts output of 300,000 carats this year, up from 257,641 carats last year, and 500,000 carats by 2013 on expansion of the Letseng mine and development of a new Botswana mine.

Gem is due to publish an updated statement of resources and reserves in April.

Clifford Elphick, chief executive, added that he expected diamond prices to jump by more than 25pc this year on Chinese and Indian demand.

"Most people in the industry continue to be surprised by the voracious appetite from the Chinese consumer for diamonds," he said. "I would be surprised if we don't achieve plus 25pc."

The view followed on from De Beers, the largest diamond miner by sales, which said last month it may raise output by 21pc to full capacity by the end of 2012 to meet "extraordinary" demand from China and India.

Last October, Lucara – which also has an interest in Lesotho – agreed to buy AIM-listed exploration company African Diamonds for C$82m (£52m) in a deal to enable both companies to benefit from a diamond discovery in Botswana.

Gem Diamonds shares rose 14.2 to 284.2p.