Why the sudden interest in diamond investing?

March 28, 2016

Originally from http://themiddleground.sg/2016/03/23/sudden-interest-diamond-investing/

 

Before the 2000s, if you talked about investing in diamonds, you’d get a knowing wink. Diamonds were controlled by a monopoly back then, and people “in the know” realised it was a safe bet. Then in 2010, the unthinkable happened: diamond prices fell, and continued to fall until the present. That’s not the puzzling part either. Despite the drop, interest over the past few years seems to be rising. Here’s what’s going on:

 

Diamond investing “back then”

 

As an investment, diamonds underwent a radical shift in the 2000s. And you need to understand how it used to work, or nothing about the market now will make sense.

Until the late 1800s, diamonds were rare. But in 1870, British colonisers in South Africa discovered the country was loaded with diamonds. There were places along the Orange River in South Africa where you almost couldn’t sip water without accidentally choking on a diamond. You could walk the riverbank with a big scoop and get bagfuls of the stuff.

 

This caused panic in the diamond industry at that time, because diamonds got most of their value from scarcity. So in 1888, some financiers formed De Beers Consolidated Mines Limited.

De Beers, a collaboration between various diamond related companies, ended up owning or controlling most of the diamond mines in South Africa, Namibia and Botswana – countries where most of the world’s high quality gemstones come from.

 

Over time, De Beers also bought or formed diamond trading firms in England, Portugal, Israel, Belgium, Holland and Switzerland.

 

By the 1980s, De Beers controlled almost 90 per cent of the world’s diamond supply. They released the diamonds in small and controlled amounts, thus maintaining the illusion of scarcity. Along with that, De Beers launched several interesting marketing campaigns and invented the phrase “a diamond is forever”.

Since they controlled the supply, De Beers could sell their diamonds however and whenever they wanted. They only dealt with invited clients and diamonds were sold 10 times a year at non-negotiable prices. Their clients then polished and cut the diamonds, and sold them to jewellers.

 

This monopoly of diamond prices rose regardless of market conditions. As far back as the 1970s, investors “in the know” about the diamond business had already begun using diamonds as an alternative investment. They felt that due to De Beers’ control, diamonds were more reliable than stocks or bonds.

 

An important caveat: There are analysts who dispute that diamonds have ever been good investments, even in the past few decades. The Wall Street Journal recently published an article claiming that, after factoring in inflation, diamonds perform worse than the typical index fund or government bond.

 

Diamonds as an investment now

 

Around the 1990s, world class diamond mines were opening up in other parts of the world. De Beers, in order to maintain control, had to buy up all the supply from these mines. They had to convince these mines to join what was, in all frankness, a cartel.

 

Rifts began to form. The Argyle mine in Australia, one of the world’s largest, broke away from the De Beers supply chain. Canadian diamond mines were un-cooperative with De Beers’ scheme and wanted to sell to the market themselves. After all, there was a huge market if they were willing to undercut De Beers by just a little bit.

By around 1998, De Beers only controlled 60 per cent of the world’s diamond supply. By the mid-2000s, De Beers had all but given up trying to control the global diamond supply.

 

The current diamond market is hence a lot less certain. Without the powerful De Beers cartel to constantly push prices up, diamond values are now susceptible to the whims of the free market. In addition, the diamond industry is beginning to open up to outsiders.

 

Companies like the Singapore Diamond Investment Exchange (SDiX), or Facets Singapore, are introducing the idea of diamond investments to a wider market. Back in the 1990s and before, investing in diamonds often meant knowing a diamond dealer and having a personal relationship with him.

 

How do people invest in diamonds?

 

For starters, they don’t buy them through retail shops. When a diamond is purchased from a jeweller, a large part of the cost goes into marketing and craftsmanship. High-end jewellers can mark up the price of a stone by as much as 60 per cent.

 

Investors purchase from a wholesaler or dealer, and almost never from big jewellery stores. These are increasingly common in Singapore. This is because, besides investors, some buyers have discovered they can get their engagement or weddings rings cheaper by buying the stone from a wholesaler or dealer.

 

The Rapaport Diamond Index and IDEX are the most commonly referred indices for diamond prices. However, diamonds are far from being at the level of stocks, bonds or commodities like oil when it comes to transparent pricing. It is possible for individual diamonds to sell for much more or less than they are “supposed” to be worth.

Diamonds are rated according to the four Cs:

  • Carat

  • Colour

  • Clarity

  • Cut

Carat

This is the weight of the diamond. One full carat is around 0.20g. A common guideline for determining value is Tavernier’s Law: the weight in carats is squared and multiplied by the base price of a one carat stone (Wt² x C = price).

In reality, Tavernier’s Law will seldom give you the accurate value of a diamond as the price will also be affected by the other conditions below.

Diamonds bought for investment purposes are almost always three carats or more. Diamonds smaller than that cannot be counted on for resale value.

 

Colour

The most valuable diamonds are usually clear diamonds (colourless). With fancy coloured diamonds, the most valuable are red, green and blue. In consumer markets, pink tends to be popular and expensive (Gee, engagement rings, take a guess why?), but are not actually as scarce as the others.

Yellow diamonds are difficult to sell in Asia, because the stone does not blend well with the common skin tones of those living in the region.

 

GIA has an official colour scale. Again, for clear diamonds, value increases with lack of colour. For fancy coloured diamonds, scarcity of the colour affects value.

Bonus tip: If you just want a more affordable clear diamond, a common way to cheat is to go for a “G” grade rather than an “F” grade. This can shave several hundred dollars off the price, and the difference will not visible to the naked eye.

 

Clarity

This measures how many imperfections there are in the diamond. Imperfections are called inclusions when they are inside the diamond, and blemishes when they are on the surface. Clarity is graded from Flawless (FL) to Included (I1 to I3).

You can check the GIA chart here.

Some inclusions are not visible once the diamond has been set in a ring, pendant, etc. (This is another reason investors seldom get their diamonds from jewellers.)

 

Cut

The cut of the diamond affects how sparkly it is. It’s determined by brightness, fire (the way the light scatters around it), and scintillation (the juxtaposition of light and dark spots).

Cut ratings go from Excellent to Poor, according to the GIA scale.

 

Are they good investments?

 

Like any high-end alternative, diamonds derive their value from having low correlation to conventional stock and bond markets.

 

Diamonds have some of the same problems that you find with wine, stamps, cars, etc. Prices can be unpredictable and there is no single global standard that determines the value of any one gem. It is very different from commodities like oil or gold, where we know for a definite fact how much one barrel or one ounce will be worth everywhere.

 

A diamond that is worth $2 million to one buyer may be worth half that to another, or perhaps double. Bidding during diamond auctions can drive prices up or down with little predictability. And without the controlling hand of De Beers, the era of controlled supply, and hence steadily climbing prices, has come to a close.

 

As of last year, diamond prices have experienced a gradual decline over five years. Most notably, De Beers posted a seven per cent decline in profit between 2014 and 2015. While they are no longer the demigods of the diamond industry, De Beers performance is still a good indicator of overall demand.

 

This has been blamed on falling demand in China. Asia has been a pillar of support for diamond prices since early 2000. When De Beers liquidated a large chunk of their inventory from 2001 to 2005, it was mostly the demand in Asia that stopped diamond prices from plummeting. China’s slowdown has been devastating for the jewellery industry in general.

 

By all appearances, diamonds are risky investments right now. But they continue to attract a lot more attention, because it becomes easier by the year to buy from wholesalers. In this respect, the dismantling of the De Beers cartel was probably a good thing.

 

This piece is part of a series on alternative investments. Other alternative investments featured include timepieces, cryptocurrencies and stamps.

Featured illustration by Natassya Diana 

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