How Diamonds Are Doing

By Julian Murdoch

Diamonds may be ... well, you know the song. But unlike Marilyn, you might not want to rely on them for your future well-being.

The Diamond Market

First, the premise. Things are tough all over, so they've got to be really bad for companies that mine and sell the world's most expensive luxury items. By common logic, there must be a buying opportunity for those interested in the sparkling gems. Right?

Well, the part about things being tough is true, especially in the U.S.

"Diamonds have been more affected in the U.S. than in other parts of the world, partially because the current economic crisis started here," said Jeffrey Fischer, president of Fischer Diamonds Inc. and honorary president of the International Diamond Manufacturers Association. He went on to say, "The U.S. luxury market has been hit hardest, though the bridal market has been very resilient."

That "bridal" is considered a market segment, especially in the U.S., should suggest just how different a market this is from greasy wool and field corn.

But elsewhere in the world, diamonds have benefited from a slightly different consumer view, one that has an eye on the long term. "The Indian and Chinese markets view diamonds with more of an eye to investment," Mr. Fischer said, much as they do gold.

Worldwide though, diamond prices have been predictably trending downward with the rest of the economy, according to the index at PolishedPrices.com - an index of polished stones of various, set weights. The price of rough diamonds has fallen 40-50% since the middle of last year, a range of losses familiar to any investor, although demand for finished, polished stones has remained stronger.

As demand has fallen, production cuts have been inevitable - just as in other mining sectors. The difference in diamonds is that diamond-mining companies, such as De Beers and Alrosa, have been accused of hoarding diamonds, unlike alumina or copper miners. And let's face it, it's a whole lot easier to hoard something that costs thousands of dollars per fifth of a gram than it is something quoted by the tonne.

Martin Rapaport, founder of the Rapaport Price List - the guide for pricing diamonds - released a statement on April 1 in which he said:

"De Beers, Russia and Angola might think they are doing the diamond industry a favor by halting production and stockpiling diamonds but, in fact, they might be laying the seeds of destruction. If diamonds lose their integrity because our industry appears to be exploiting consumers during a recession, then all the king's horses and all the king's men won't be able to put Humpty Dumpty back together again."

It could seem like an unfair accusation - producers sometimes have no choice but to slow or stop mining when the cost of their product falls. But in the case of diamonds, the industry has a long history of monopoly control by closely held giant De Beers, which has in the past artificially limited supply in order to maintain the perception of scarcity and drive up the price, kind of like a one-man OPEC.

Regardless, the production cuts have occurred anyway (and De Beers lost most of its stranglehold on the diamond industry years ago). De Beers has cut production 40%, and just recently the No. 2 diamond producer, Alrosa in Russia, said it would reduce production by 20%. Alrosa has also reportedly asked the Russian government not to sell diamonds from the state repository in order to help support prices. Yes, there's a Russian state diamond depository. Sounding more like gold all the time?

Commodity Or Consumer Good?

The accusation of hoarding highlights a key issue surrounding diamonds as an investment vehicle - are diamonds a commodity? If you ask most diamond guys, they get antsy over the subject. "There are people in the industry that are interested in promoting futures and derivatives on diamonds," acknowledged IDMA's Fischer.

"But I am reluctant to support those ideas at this time, feeling that some basic questions have not yet been answered. The most basic one being - do diamonds truly act as commodities, or do they just mimic commodities? Are diamonds just a consumer product - albeit one based on a beautiful and scarce natural resource?"

It's a critical question. Diamonds, like gold, are a mineral of surprisingly little utility, certainly in relation to how they are priced. If they are truly just a consumer product, Fischer asserts, "they have no business being the underlying for a futures contract."

But Fischer is also quick to point out that he understands the appeal."All that said, diamonds have actually fared comparably well when compared to other luxury goods or stocks during times of big inflation spikes." In the late ‘70s, the last time we had crazy inflation; diamonds were featured on the covers of magazines and in newsletters as an inflation hedge. "For most people it didn't work. As soon as the inflationary times broke, gold, oil and other commodities, including diamonds, went down in value," concludes Fischer.

The issue isn't just the notional "price" of a diamond investment, it's simply one of access. There are also the very real obstacles to trading physical diamonds if you do not have direct access to the diamond market. First - where are you going to buy the diamonds? From your local jeweler or a diamond broker? In either case, you will end up paying haggled retail prices. When you go to sell your investment diamonds, to whom will you sell? The same party you bought them from, and even assuming they will buy them back, they will need to buy them for less - generally a lot less - than retail price so that they can turn around and sell them at a profit.

However, there are a few ways to get access that don't involve grabbing a loupe.

Since Jan. 1 of this year, there is an actual electronic market for diamonds. DODAQ (Dealers Organisation for Diamond Automated Quotes) -- an online electronic diamond exchange -- offers two-way auctions for categories of round, polished stones. In its press release the day it went live, CEO Simon Okuniew said, "In recent years certifying diamonds has become an industry standard. By standardizing diamonds we are realistically able to call them a commodity and therefore trade them as such."

It sounds good, but it's a young exchange, with hefty fees (north of 1%, or 3% if you're not taking physical delivery), on top of the difficult-to-gauge but very wide spreads inherent in the diamond market.

Buying Cows

Of course, there's always the pick-and-shovel option.

For a pure play, it would be nice to buy De Beers, but since it is not a publicly traded company, you can only get exposure through Anglo American (NASDAQ:AAUK), which owns 45% of the company. Anglo American has lost over 70% of its stock value in the past year, but only about 12% YTD. By buying Anglo, you are also gaining exposure to precious metals gold and platinum group metals as well as base metals and coal.

And for another diamond miner with a base metals twist, you could go back to trusty Rio Tinto (NYSE Arca:RTP). Rio Tinto is the proud owner of the world's largest supplier of diamonds - the Argyle mine in Australia. Rio Tinto has been on a tear lately - after seeing its stock fall over 70% in the past 12 months, Rio Tinto's stock price is back up 60% since the beginning of January. Of course, the stock performance has little to do with diamonds, and much more to do with organizational and financial decisions - a common refrain when we talk about the difference between direct commodity investing and pick-and-shovel investing.

To play the actual luxury market end of it (instead of the miners side) there is always Harry Winston Diamond Corporation (NYSE Arca:HWD), which not only buys and sells the polished stones for its high-end jewelry, but deals in the rough diamonds as well. Harry Winston has also taking a beating in the past year, with its stock crashing 81%. But since Jan. 2, Harry Winston has bounced back 9.58%.

Finally, the idea of setting up a diamonds derivatives market has been floating around the industry for years - but nothing much has been publicly mentioned since 2007 when the reality was still a ways off. Two companies that were working on the idea back then were The Rapaport Group and PolishedPrices.com.

Comments

[logicalthought:]

All I know is, my girlfriend's been bugging me for one for a year and a half, and I'm doing everything I can to stall long enough for the plunge in polished stone prices to catch up with the plunge for rough ones!

Apr 20 01:40 PM

[wolf411:]

The article seems to imply that Harry Winston is strictly a retail play, but they are also on the mining side. They have a 40% interest in the Diavik diamond mine, which generates about half of the Harry Winston revenue.

Apr 20 03:17 PM

[Rohan C. Pease:]

HWD is a miner like BHP Billiton, just with a unbelieveable cashe, they are vertically integrated and own a 40% interest in the Diavik mine which has bought in investors such as Kinross, and is probably the highest quality mine in the world. HWD is severly undervalued and reported decent earnings during the last 12 months. DIsclosure: Long HWD shares.

Apr 20 03:59 PM

[The Geoffster:]

Diamonds are neither scarce nor precious. They are cheap stones whose price is manipulated by the De Beers cartel. Through slick advertising, the cartel has managed to con buyers into believing they are valuable. Just try to resell one for what you paid for it. Buy CZ instead.

Apr 20 07:56 PM

[cameroni:]

You would think things would be "tough for companies that mine and sell the most expensive luxury items". The only problem with your premise is that more than 75% of all diamonds mined actually go to industrial uses like polishes, grinding wheels, mining equipment, drills and cores etc. The diamond business is still a very good business to be in and should improve rapidly with an economic recovery. Miners are not wholly banking on finished stones getting to market to turn a profit because industrial applications are the main market and markups in finished stones have very little bearing on direct mining operations. There is quite a lot of good synthetic diamond production but the real thing is still the best. (my opinion only)

Cam

Apr 21 03:28 AM

[Gedankonomist:]

Another interesting fact about diamonds has to do with the deBeers slogan "Diamonds are forever." They are not forever. Just take one and hold it over a flame.


On Apr 20 07:56 PM The Geoffster wrote:

> Diamonds are neither scarce nor precious. They are cheap stones whose
> price is manipulated by the De Beers cartel. Through slick advertising,
> the cartel has managed to con buyers into believing they are valuable.
> Just try to resell one for what you paid for it. Buy CZ instead.

Apr 21 04:22 PM

[Ergo:]

Once upon a time, I explained all the faults of diamonds to my girlfriend (now wife). She politely expressed her view that she didn't care, and she wanted something large and sparkly to stare at and show off. So although the rock may not have much intrinsic worth, the value of a happy wife is somewhat immeasurable. And unless someone finds a diamond mine in Colardo, the cartels aren't going to get broken anytime soon.

Apr 22 07:21 PM