Diamonds as an investment

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For the chemical,optical&physical properties and applications of diamonds, please see diamond.

This article discusses the role of diamonds as an investment.

An uncut diamond does not show its prized optical properties.
An uncut diamond does not show its prized optical properties.

Contents

[edit] History

Diamonds have been treasured as gemstones since their use as religious icons in India at least 2,500 years ago. Popularity of diamonds has risen since the 19th century because of successful advertising, increased supply, improved cutting and polishing techniques, and growth in the world economy. Diamonds are not normally used as a mainline store of value during times of crisis, due to their lack of fungibility and low liquidity. However, they may still be useful during times of hyperinflation.

Approximately 20% of mined diamonds are used in jewelry and 80% for industrial uses (such as lasers, drill parts and surgical equipment).

Chemical vapor deposition is now used to produce cultured diamonds which, unlike diamond simulants, require very close inspection to distinguish them from natural diamonds.

[edit] Diamond price

Historically, the wholesale diamond price has been controlled by De Beers Group, which has an estimated 45 to 50% of the market. Botswana is currently the largest producer of diamonds with mines operated by Debswana, a joint venture between De Beers and the Botswana government. However, over the last decade other producers have developed new mines in Russia, Canada and Australia for example, challenging De Beers' dominance (historically De Beers market share has been 80%). De Beers raised wholesale diamond prices three times in 2004 by a total of 14%.

The United States is the biggest consumer of diamonds in the world. The U.S. accounts for 35% of diamond sales, Hong Kong 26%, Belgium 15% (Antwerp is the world's diamond-trading centre), Japan 6%, and Israel 4% [1]. The price of diamonds fluctuates with global demand and the world economy. For example there was a slump in demand during the Great Depression.

Diamond prices vary widely depending on a diamond's carat, color, clarity, cut and shape. In contrast to precious metals, there is no universal world price per gram for diamonds.

[edit] Feasibility as an investment

Diamonds will never appreciate in value relative to their current market rates, as there is no natural shortage of them. Diamonds can be synthesized at much lower cost than the current diamond cartel is asking for them, and the chemical and structural purity of a synthetic diamond can exceed a natural one[citation needed]. However, the chemical composition is not the only factor that determines their value - the quality of the cut is of as much if not greater importance.

Diamonds are a problematic investment. While it is easy to buy a diamond, it is not easy to sell one unless one is already an established diamond merchant. Another problem for investors is that purchasers other than established jewelers will be paying retail for a stone but can get only wholesale at most if they sell it back to a jeweler. If buying from nonindustry sources, fraud is a major risk and even retail jewelers are skittish about it following Jewelers Vigilance Committee warnings in the 1990s about numerous fraud schemes by customers selling jewelry to jewelers or bringing it in for repair.

There are firms that offer "investment-grade" diamonds for sale to the public: a prudent investor should ask for a written promise to rebuy the diamonds at or near the purchase price within a specified period.

[edit] Methods of investing in diamonds

[edit] Polished diamonds

Cut and polished diamonds.
Cut and polished diamonds.

Polished and rough diamonds lack some of the desirable attributes of investment vehicles, including liquidity, homogeneity and fungibility. Grading and certification by recognised laboratories goes some way to redressing this. Weight and cutting proportions are parameters which can be precisely measured. Colour and clarity grades are parameters which need to be determined by gemologists.

The increasing quality and size, and decreasing price, of synthetic diamonds also presents a threat to the value of polished diamonds as a long-term investment.[citation needed] The possibility of low-cost ultra-high-quality diamonds becoming available in industrial quantities at some time in the future is not an encouraging prospect for long-term investors in diamonds.[citation needed]

A cautionary example of such a price fall caused by introduction of a new simulant strongly undermining the prices of a natural gem was the permanent fall in natural pearl prices with the introduction of cultured pearls. The mechanism by which prices were affected is complex. In part because of the social acceptability of wearing cultured pearls to much of the market, customers migrated from the natural to the lower priced cultured product. This altered the supply and demand situation for natural pearls and perhaps the overall prestige of pearls in general was lowered. Where synthetic stones are less socially acceptable to the market for the natural version, arguably as with synthetic corundums where the two markets, natural and synthetic are mostly separate, the prestige of the natural stones has been, with effort, retained. Thus increased availability and lowered prices of synthetics may or may not have major implications for the future price of natural diamonds.

There are several factors contributing to low liquidity of diamonds. One of the main is the lack of terminal market. Most commodities have terminal markets, and some form of commodities exchange, clearing house, and central storage facilities. This does not exist for diamonds. Diamonds are also subject to value added tax in the UK, EU, and sales tax in most developed countries, therefore reducing their effectiveness as an investment medium. Most diamonds are sold through retail stores at very high profit margins. This is due to high overhead costs of operating a jewelry retail store.[citation needed]

As diamonds in larger sizes become increasingly rare and valuable, any easily visible and readily understood pricing system has been difficult to establish. Martin Rapaport produces the Rapaport Diamond Report, which lists prices for polished diamonds. The Rapaport Diamond Report is relatively expensive to subscribe, and is of course copyright, and as such is not readily available to consumers and investors. Each month, there are matrices of diamond prices for round brilliant cut diamonds, by colour and clarity within size bands, and also other shapes. The price matrix for brilliant cuts alone exceed 1,400 entries, and even this is achieved only by grouping some grades together. There are considerable price shifts near the edges of the size bands, so a 0.49 ct stone may list at $5,500 per carat = $2,695, while a 0.50 ct stone of similar quality lists at $7,500 per carat = $3,750. This may appear such a large difference as to defy logic, but in reality stones near the top of a size band tend to be uprated slightly. Some of the price jumps are related to marketing and consumer expectations. Somebody[who?] expecting a 1 carat (200 mg) diamond solitaire engagement ring may be unprepared to accept a 0.99 carat (198 mg) diamond.[citation needed]

There are numerous diamond grading laboratories, and there is no easy way for investors, consumers, or even dealers to know the relative competence and integrity of each. Even the market-leading Gemological Institute of America (GIA) suffered embarrassment recently when a small number of large, important and valuable diamonds were overgraded, resulting in legal action by one dealer against the dealer who had submitted them to the GIA for grading. A number of GIA employees left after the scandal emerged, and the GIA has changed a number of its procedures. There are also a number of laboratories affiliated to CIBJO. There must be commercial pressure on all labs to upgrade marginal stones or lose business to other labs who are prepared to reduce standards.

Leaving the concept of fungibility to those expert economists who understand it, the non-linear pricing of different sizes (weights), means that it is not realistic to exchange, for example, 2 quarter carats (50 mg) for 1 half carat (100 mg), even if their relative values can be calculated. With commodities such as gold, it is clear that 1 twenty gram bar is worth the same as 2 ten gram bars, assuming the same quality. In most terminal markets, there needs to be a readily available standard quality, or limited number of qualities, available in sufficient quantity to be tradable. It is this factor which affect liquidity. There are far too many variables in diamond quality, and an almost infinite graduation of each quality parameter.

There are fashion and marketing elements to take into consideration. De Beers expends marketing efforts to encourage sales of diamond sizes and qualities which are being produced in relatively large quantities. They have also been known to take steps to discourage investment, primarily because they perceive, probably correctly, that bubble prices which are followed by sharp falls, are bad for long term consumer confidence in diamonds as a long-term store of value. Diamonds are primarily a consumer item.

The main positive investment parameter of diamonds is their high value per unit weight, which makes them easy to store and transport. A high quality diamond weighing as little as 2 or 3 grams could be worth as much as 100 kilos of gold. This extremely condensed value and portability does bestow diamonds as a form of emergency disaster fund. People and populations displaced by war or extreme upheaval have utilised this property successfully, and presumably will do so again in the future.

The arguments given mean that it is almost certain that diamonds can never be commoditized sufficiently to allow efficient and sufficiently liquid markets. This does not mean however that diamonds can never be used or considered as investments. The very lack of liquidity itself could be used by a speculator who was prepared to make a market in diamonds. Any such investor would need to ensure that he maintained sufficient personal liquidity to avoid distress selling, except by others. Such an investor would need to expend effort to market his stock, and to advertise his readiness to buy and would effectively become a trader rather than investor.

[edit] Mining companies

See also: Category:Diamond mining companies

These do not represent diamonds at all, but rather are shares in companies that mine diamonds. The largest diamond company in the world is De Beers, which is jointly owned by Anglo American (45%), the Oppenheimer family (40%) and the Botswana government (15%).

The Argyle mine in Australia (owned by the Rio Tinto Group) is the largest single producer of diamonds in the world.

[edit] Taxation

Diamonds are subject to value added tax in the UK, EU, and sales tax in most developed countries. Other taxes such as capital gains tax may apply for individuals depending on citizenship and if the asset is sold at increased value.

[edit] References

[edit] See also

[edit] External links