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Why should one invest in diamonds?

    IndianMoney.com Research Team | Monday, February 09,2009, 03:54 AM
 

History

Diamonds have been cherished as gemstones since the ancient times. Popularity of diamonds has increased since the 19th century because of successful advertising in spite of an outrageously increased supply. Diamonds are not usually used as a mainline store of value during times of crisis, due to their lack of fungibility and low liquidity. Though, they may still be useful during times of hyperinflation. Roughly 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, different diamond simulants, require very close inspection to distinguish them from natural diamonds.

Diamond price

In olden times, the wholesale diamond price has been controlled by De Beers Group, which has an estimated 40% to 50% of the market. Botswana is presently the largest producer of diamonds with mines operated by Debswana, a joint venture between De Beers and the Botswana government. However, since the 1980s, other producers have developed new mines in Russia, Canada and Australia for e.g., challenging De Beers' dominance (historically De Beers market share was considerably higher, e.g. 80%. De Beers through its trading company called as the DTC raised wholesale diamond prices three times in 2004 by a total of 14%.

The US is the largest 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%, Israel and Belgium are significant Hubs for trading diamonds thus consumption numbers are a bit misleading. The price of diamonds varies with global demand and the world economy.

Diamond prices vary generally depending on a diamond's carat, color, clarity and cut (The 4 C's). In contrast to precious metals, there is no universal world price per gram for diamonds. However the industry does use tools like the Rapaport Diamond Report and The Gem Guide which are published weekly or quarterly, as a price references.

In addition to print and online references, numerous institutions have changing standards which can be used to aid in diamond identification and pricing. Gemological Institute of America, American Gemological Society and International Gemological Institute are 3 such institutions. Often these organizations center on new research and education which they pass on to their members and the public.

Feasibility of using diamonds as an investment

There is no natural scarcity of diamonds. Diamonds can be synthesized at much lower cost than the equivalent natural diamond price and the chemical and structural purity of a synthetic diamond can surpass a natural one. However, the chemical composition is not the only factor that concludes their value - the quality of the cut is of as much, if not greater, importance.

Diamonds are a troublesome investment. While it is easy to buy a diamond, it is not easy to sell one unless one is already a well-known diamond merchant. Another problem for investors is that purchasers other than well-known 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 non-industry sources, fraud is a major risk and even retail jewelers are skittish about it following Jewelers Vigilance Committee warnings in the 1990s about many fraud schemes by customers selling jewelry to jewelers or bringing it in for repair.

Some companies offer "investment-grade" diamonds for sale to the public. A cautious investor must ask for a written promise to rebuy the diamonds at or near the purchase price within a particular period.

Today there are a small number of funds that are investing in diamonds. These funds buy unique diamonds (very large in size or color); each stone is checked by a few professionals and negotiated until the fund decides to purchase it. Then a marketing team goes into action and through a widespread work the fund yield is gained. Between 2007 and 2008 the price of a diamond from the top range of color, clarity, cut and carat went up by over 50%.

Methods of investing in diamonds

  • Polished diamonds
  • Cut and polished diamonds

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

The increasing size and quality, and decreasing price, of synthetic diamonds also presents a threat to the value of polished diamonds as a long-term investment. The likelihood 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. However, synthetic diamonds have been manufactured since the 1950s and have yet to make a main impact on the market.

A warning 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 composite. 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 changed 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 frequently separate, the prestige of the natural stones has been, with effort, sustained. Thus increased availability and lowered prices of synthetics may or may not have main implications for the future price of natural diamonds. The drop in natural pearl prices was also affected by the onset of the Great Depression and the development of the oil industry in the Persian Gulf (which not only provided pearl divers with better-paid, safer jobs, thereby rising production costs and lowering production capacity, but also increased pollution in the gulf, thereby reducing supply) - neither of these factors apply to diamonds. Besides, the introduction of synthetic rubies in the late 19th Century did not appear to have a permanent effect on the price of natural rubies.

There are many factors contributing to low liquidity of diamonds. One of the major is the lack of terminal market. The majority of 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 United Kingdom, EU, and sales tax in most developed countries, therefore reducing their effectiveness as an investment medium. A good number diamonds are sold through retail stores at very high profit margins.

As diamonds in larger sizes become increasingly rare and valuable, any easily visible and readily understood pricing system has been hard to establish. Martin Rapaport produces the Rapaport Diamond Report, which lists the prices for polished diamonds. The Rapaport Diamond Report is relatively expensive to subscribe to, and as such is not easily available to consumers and investors. Every week, 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 surpasses 1,400 entries, and even this is achieved only by grouping some grades together. There are considerable price shifts close to 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 big 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. A buyer expecting a 1 carat (200 mg) diamond solitaire engagement ring may be not ready to accept a 0.99 carat (198 mg) diamond.

There are many 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 big, significant and precious 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 scandals appear, and the GIA has changed a number of its procedures. There are many laboratories affiliated to CIBJO (Confederation International de la Bijouterie, Joaillerie et Orfèvrerie, also known as the World Jewelery Confederation). There must be commercial pressure on all labs to upgrade marginal stones or lose business to other labs that are prepared to trim down standards.

Leaving the concept of fungibility to those expert economists who understand it, the non-linear pricing of different sizes (weights), which means it is not realistic to exchange, for e.g., 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, expecting the same quality. In the majority 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 issue which affects liquidity. There are lot many variables in diamond quality, and an almost infinite graduation of each quality parameter.

There are fashion and marketing elements to consider. De Beers expends marketing efforts to encourage sales of diamond sizes and qualities which are being produced in relatively huge quantities. They have also been known to take steps to deject investment, mainly 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 mainly a consumer item.

The major 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 value as much as 100 kilos of gold. This awfully condensed value and portability does bestow diamonds as a form of emergency disaster fund. People and populations displaced by war/extreme upheaval have utilized this property successfully, and presumably will do so again in the future.

The arguments known mean that it is almost certain that diamonds can never be commoditized sufficiently to allow efficient and sufficiently liquid markets. This does not mean, though, that diamonds can never be used or considered as investments. The very lack of liquidity itself could be used by a speculator who was ready to make a market in diamonds. Any such investor would need to make sure 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 willingness to buy and would effectively become a trader rather than investor.

Funds

In 2008 Diapason Commodities Management listed an investment company called Diamond Circle Capital, which intends to invest in rare colored and colorless diamonds worth more than $1m each. As of July 2008 the IPO for the closed-end fund was postponed until additional notice.

Mining companies

These do not represent diamonds at all, but rather are shares in firms that mine diamonds. The major 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 principal single producer of diamonds in the globe.

Taxation

Diamonds are subject to value added tax in the EU, and sales tax in most urbanized countries. Other taxes like capital gains tax may apply for individuals depending on citizenship and if the asset is sold at increased value. Rough diamonds are also subject to taxation and in the future days all rough diamond mined in South Africa will be subject to a 7% royalty.

IndianMoney.com Research Team

The research team at IndianMoney.com comprises of certified and experienced professionals who share the company's vision to make every Indian financially literate by equipping every Indian with right and unbiased advice. IndianMoney.com research team provides newsletters, articles, videos and FAQs on various financial products and concepts only to help you make wise financial decisions.

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