Diamond Investing FAQ

February 18, 2014
By Paul Zimnisky


Below are responses to diamond investment related questions:


How can I track diamond prices real-time? 
Since there not a centralized spot or futures market for diamonds, “real-time pricing” does not exist the way that it does for stocks or fungible commodities.  Given the unique characteristics of each diamond, there is technically a separate market for each category of diamond, of which there can be upwards of 12,000 categories. There is also a separate market for rough and polished diamonds.  That said, there are still ways to actively track diamond prices.

Rough diamonds can be priced using publicly released sales figures by miners.  Most miners will press release average selling price on a per-carat basis after large diamond sales or include this information in regular financial reports.  Miners will also usually provide specific selling price information on larger notable diamonds sold (see Image 1).

Polished diamond prices are typically more readily available than rough and can sourced through diamond consulting companies like IDEX and Rapaport that publish pricing data on a fairly regular basis broken down by category of diamond.  Another option for pricing polished is to monitor prices on the web via online diamond retailers.  Retailers represent the real market (at least one-side of the market), and the online retailers websites have interfaces that make searching for specific diamonds very easy.  Lastly, the fine auction houses tend to provide the best source of pricing for rarer polished diamonds.  Sotheby’s and Christies provide sales data for completed auctions on their websites. 

Those interested in a general proxy for diamond price trends can access a handful of subjectively created diamond indexes distributed by WWW Intl. Diamond Consultants, Rapaport, and IDEX.  These indexes are typically updated at least weekly. 
 
Image 1: A 29.6 carat fancy blue rough diamond recovered by Petra Diamonds in January 2014 
and sold in February for $25.6 million.  Source: Petra Diamonds Ltd.

What is the best way to value a diamond?
The first step in valuing a diamond is to accurately determine the characteristics of the diamond being valued, which requires expertise, equipment, and experience, or a reputable professional diamond grading service such as GIA.  Once the classification of the diamond has been determined, one of the methods mentioned above can be used as a starting point to indicate recent transaction prices for a similar stone.  

Next, directly access the market.  Go out and find how much someone is willing to pay for the diamond.  The point where a buyer and seller are willing to meet on price is the truly the best indication of value.  The fair value of a diamond will fall somewhere in-between the range of where you can buy a similar diamond and where you can sell the diamond you are looking to value.  Be aware that the spread between where someone is willing to sell and buy a similar diamond can be relatively wide because there are more sellers than buyers in the secondary diamond market. 

Is the value of diamonds an illusion created by De Beers?
Yes and No.  

No, in that supply and demand ultimately determine value.  There is an intrinsic global demand for diamonds and supply is limited by nature and mining economics. 

Yes, in that De Beers influences supply and demand.  De Beers created demand for diamonds with its ultra-successful marketing campaign, and De Beers controls its own diamond supply to an extent, which currently represents 35-40% of global market share.   

How rare are diamonds really?
Diamonds in the size and quality that most people want are rare, as these diamonds are limited by geology and mining economics.  

While the general geological occurrence of the mineral diamond may not be perceived as rare, diamond deposits that are economic to mine are.   For instance, gold is contained in every rock in the earths crust in some quantity, but gold cannot be economically extracted from most rocks unless the grade of gold is high enough to justify the costs to produce it.   The same is true for diamonds in that the size, quality, and occurrence of diamonds have to be great enough to justify the production cost of a deposit.  

Kimberlite pipes are the geological formations that serve as the primary source of mined diamonds.  About 6,400 kimberlite pipes have been discovered in the world, of those about 900 have been classified as diamondiferous, and of those just over 30 have been economic enough to diamond mine.

Does De Beers fix diamond prices?
De Beers sets the prices of their own diamonds, but they no longer have the market share to fix the global market as a whole.  

De Beers offers most of its diamonds for sale via pre-arranged contracts with select large buyers called Sightholders at events referred to as Sights. De Beers sets non-negotiable prices for its diamonds sold at Sights.  Sightholders agree to buy from De Beers this way because they are assured a reliable source of diamonds in the quantity and quality needed at predictable intervals. 

As recently as the mid-1980’s when De Beers controlled almost 90% of global rough diamond supply, the Sightholder system gave the cartel a tremendous amount of pricing power which was used to target diamond prices at a trajectory that was stable but gradually rising over time.  Beginning in the 1990’s, the emergence of new competition reduced De Beers market share to less than 40%.  Today as a global market, De Beers and its competitors sell approximately 60% of inventory via long-term contracts like Sights, and the balance of sales are conducted through auctions and one-time sales where current market forces prevail.   The portion of sales that occur in the open market, influences the prices set at Sights and other similar contract sales systems.

Is investigative journalist Edward Jay Epstein correct when he states that diamonds are “the most common element in the world”?  
No, technically diamonds are not even an element.  Diamonds are a mineral composed of the element carbon. Oxygen is the most common element in the earth’s crust, and hydrogen is the most common element in the universe.   

While the presence of the mineral diamond could be perceived as abundant, economically accessible diamonds in the size, quality, and color that buyers want are by no means common.

How will the diamonds discovered in the Popigai crater in Russia impact global supply?
The Popigai crater headline got a lot publicity in September 2012, but there have since been no further developments. My understanding is that there are diamonds present in the crater, but the diamonds are of very low quality, so low-quality that it is not economic to produce them. Generally speaking, diamonds fall into two categories, gem-quality and industrial-quality. Diamond mines produce both qualities of diamonds, but without gem-quality diamonds a mine will not be economic.  Very low quality diamonds for industrial application are more economic to produce synthetically than by mining, so the Popigai crater should have no impact of gem-quality diamond supply.

Image 2: A satellite view of the Popigai crater. Source: Google Earth.

Will the ability to make higher quality synthetic diamonds make natural diamonds worthless?
I don’t see the emerging presence of high quality synthetics making natural diamonds worthless, but some demand for natural diamonds may be lost to more widely available synthetics in the years to come.  The presence of synthetics does not in any way alter the finite supply of natural diamonds, as technology exists to distinguish between natural and synthetic diamonds.

How do I know if I am buying a synthetic or a natural diamond?
Synthetic diamonds are produced in an environment that replicates nature, making synthetic diamonds chemically identical to natural diamonds.  However, with proper equipment, fluorescent colors and patterns of a diamond can be used to differentiate a synthetic from a natural.  But without proper equipment, it can be nearly impossible to identify a synthetic, so trust in the source that you are buying from is essential. 

What is kimberlite?
Kimberlite is an igneous rock (cooled magma) found in geological formations referred to as kimberlite pipes.   Kimberlite pipes are the primary source of mined diamonds.  From a cross section view, a typical kimberlite pipe is shaped like a carrot, widest at surface, narrowing at depth.

Approximately 6,400 kimberlite pipes have been discovered in the world, of those approximately 900 have been classified as diamondiferous, and of those just over 30 have been economic enough to mine for diamonds.

How do I know if I am buying a blood diamond?
Some high-end diamonds are inscribed with a label specifying a responsibly sourced origin, examples being De Beer’s Forevermark Diamonds (see Image 3), and Canada’s Ekati mine Maple Leaf Diamonds.  However, without an inscription it is impossible to know for sure the true origin of a diamond, so trust in your source and their distribution channel is all that you have.  

Image 3:  A diamond with a microscopic Forevermark inscription and origin 
identifying serial number.  Source: De Beers Group.

How does the Kimberly Process work?
The Kimberly Process is a United Nations backed system that was enacted in 2003 aimed at halting the global trade of rough diamonds tied to the financing of rebel movements seeking to undermine legitimate governments.  The governments participating in the Kimberly Process distribute rough diamond “passports” only to the miners in their country that follow the principles of the Kimberly Process, theoretically banning the export of rough diamonds linked to rebel movements.  

While the Kimberly Process has achieved its defined goal of reducing the trade of diamonds used to fund rebel movements, the Process has received scrutiny for not taking a stronger stance against other human right violations tied to diamond trade.  Global Witness, a human right group and a founding participant of the Kimberly Process, resigned from the Process in 2011 after (as it states) governments including Zimbabwe have “dishonored, breached and exploited the system without bearing any consequential penalties.”  

The Kimberly Process could be more effective if it were to broaden its mandate to include halting diamond trading related to any and all human rights violations.

What is the best way to invest in diamonds?
I think it is very important to make the distinction between speculating in diamonds and buying diamonds as a store of value.   

Speculating short-term in diamonds can be a difficult proposition given the expertise required and the relatively wide market spread (the difference between where you can buy and sell).  I believe the best way to speculate on diamonds short-term is with diamond mining equities that have historically proven to be a good proxy for diamond prices.  Companies with a high correlation to diamond prices should benefit from increases in cash flow and in situ resource valuations if diamond prices increase at a faster pace than production costs.   Dominion Diamond Corp (TSX: DDC) and Petra Diamonds (LSE: PDL) represent large, relatively liquid diamond mining equities traded in North America and Europe respectively. 

Buying diamonds as a longer-term store of value, or a wealth preservation tool can be a viable strategy.  Historically rare, high-quality diamonds have performed best, which can be purchased through a wholesaler, auction, or even a reputable online retailer given that you posses the expertise required.   I would define a high-quality diamond as over 1 carat in size, flawless, colorless or fancy, with an ideal cut in a popular shape, which can start at around $20,000.  

Are diamonds an effective inflation hedge?
I would put high-quality diamonds in the same category as other tangible assets with limited availability that have a history of steady demand.  Assets such as fine artwork, classic cars, or even very rare baseball cards have historically kept up with or even exceeded inflation rates.   Buying lower-quality diamonds as a store of value or inflation hedge can be difficult given the high transaction costs associated with this quality diamond relative to their value.  

How difficult is it to sell a diamond in the secondary market?
Most of the larger “corporate” jewelers do not buy-back diamonds from customers, which leaves independent retailers, pawns, and auctions as the primary marketplaces for selling diamonds on the secondary market.   In the U.S., New York’s diamond district is a relatively good market for selling because of the high number of willing buyers in such a concentrated area.

Selling a branded diamond or a diamond that has been professional graded by a reputable institute with proper documentation will tend to yield the greatest price as it reduces the buyers risk.  Most independent retailers do not possess the equipment to properly grade a diamond brought in for sale by a customer.  From the perspective of a retailer, they can buy inventory from a trusted wholesaler or they can buy from a customer at a discount to wholesale, but take on greater risk of what they are buying in the process.

Why are colored diamonds so expensive?
In most cases the complete absence of color makes a diamond more valuable, but when the color of a diamond falls outside of the normal color range, a diamond is considered to be “fancy”.  Fancy diamonds with a desirable color and tone are in high demand but are rare making them quite valuable.   Large saturated pink and blue diamonds with good clarity are extremely rare and tend to be the most expensive of all diamonds.   The two most expensive diamonds ever sold at auction were fancy pinks selling for $83 million (see Image 4), and $46 million respectively. 

Image 4: A 59.5 carat fancy pink diamond sold for a world record $83 million on 
November 13, 2103 at a Sotheby’s auction in Geneva.  Source: Sotheby’s.

Do you think a physical diamond Exchange Traded Fund will be launched soon?
While a physical diamond Exchange Traded Fund or ETF is theoretically plausible, I believe the strained mechanics of the structure would greatly slow down the regulatory approval process.

In the case of a physical diamond ETF, the diamonds backing the shares of the fund need to be physically held in a custody account.  The challenge arises when demand warrants new shares to be created but the quantity and quality of diamonds needed to back the shares as outlined in the prospectus are not readily available.  The financial institution creating the new shares, called the Authorized Participant, could have difficulty procuring the exact category of diamonds needed at a moment’s notice, which would strain the structure of the fund. A physical diamond ETF will not be launched until the fund structure is approved by regulatory authorities, and regulators will be apprehensive to approve a fund structure that has liquidity constraints given the nature of the underlying security. 

A closed-end fund structure, in which the fund’s shares outstanding and underlying assets are relatively fixed, is a more appropriate structure for a physical diamond fund in my opinion.

Why have junior diamond companies historically performed so poorly?
There has been a lot of money raised and spent on exploration for diamonds, but the success rate has been very low.  Out of the discoveries that have been made, only a handful have been economic enough to develop into mines.   The track record of diamond exploration/development companies as a group has been relatively poor which has translated to poor stock performance for most of the companies in the space.  Aber Diamond Corp, later named Harry Winston Diamond Corp and now known as Dominion Diamond Corp, is an example of one of the few junior diamond success stories. 

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