Are Diamond Miners The Next Big Thing In Resource Investing?

Includes: DDC, GMDMF
by: Simit Patel

Since the turn of the century, the market for investing in companies that get stuff out of the ground - in other words, mining and drilling companies - has produced some outstanding returns. Consider:

  • Gold has gone from $250 to its current price of over $1,600
  • Silver has gone from $4 to over $30
  • Uranium went from $8 to over $130 in the uranium bubble of 2007
  • Rare earth miners like Molycorp (MCP) experienced an eight-fold appreciation in 2010-2011
  • And now, a graphite bubble appears to be emerging

So what's next?

Well, while I believe all of the aforementioned are still in bull markets and that the biggest and longest lasting mania will be in gold and select gold mining stocks, I think diamonds may be an area resource investors will increasingly benefit from focusing on. Here's a rundown of the case for higher diamond prices:

  • The sovereign debt crisis is alive and well, as governments around the world have only added more debt to the system. More sovereign debt creates fears that governments will not be able to pay back their debt, and that they will need to monetize debt - i.e. print money - to make payments. As the market grows more fearful of this, the case that wealthy individuals will run out of cash and into precious metals, gems, and art objects to preserve their wealth in forms that do not take much space and thus are more easily portable and tradeable grows stronger.
  • Diamond prices have been on the rise this year already. For the Jan. 1 to April 15 period, the sales value of Gem Diamonds' (OTC:GMDMF) - a diamond miner - rough diamonds rose 46% to $24.3 million.
  • A recent article in USA Today pitches the idea of diamonds as an investment. Normally I view such articles in mainstream publications as a contrary indicator, but as there is no real widespread talk of investing in diamonds, I think this could just be positive marketing that helps the idea gain more acceptance. When lots of articles about diamond investing appear and when there is hysteria around the idea, I'll be inclined to view things differently. The article does note that diamond ETFs would have trouble pricing diamonds, a point I agree with; I think those that invest in diamonds as a form of speculation would be better off going with a mining firm that has the right contacts to deliver product to a luxury market as well as the mining skills and property to bring quality diamonds to the market in a cost-effective manner.
  • As is the case elsewhere in the resource sector, the bull market in diamonds is currently being driven by China and India. The emerging middle class in those economies are helping to boost the demand for jewelry and luxury goods. At the same time, there may be structural shortages leading to a decline in diamond output, according to industry researchers at Bain & Co. Bain & Co. is forecasting diamond prices to grow at an annual rate of greater than 6% through 2020.

I think there is still time for investors to thoroughly study this market to find the best opportunities, which is certainly something I plan on doing. At this point, I'm especially intrigued by tiny diamond mining stocks that have a market capitalization of under $50 million. There are some promising stories out there and I think some of them that have real prospects could generate outstanding returns. There are also data points that suggest the industry is investing in long-term growth. Consider, for instance, the onset of the first diamond mine in Quebec, which should go into production in 2015. As jurisdictions warm up to the opportunities in diamond mining, more opportunities for mining firms are likely to emerge.

For those looking for a more developed diamond mining company to invest in, one larger firm that I've recently added to my watchlist is Harry Winston (HWD), which comes in with a market cap of $1.18 billion at the time of this writing. HWD does have positive earnings and a P/E ratio of over 46, which I find to be a bit of a turn-off. I prefer to see P/E ratios below 20, but of course there will always be exceptions and HWD may be worthy of such a distinction. The firm employs a strategy of deep vertical integration, going all the way from having a 40% stake in certain mines to owning and operating luxury stores around the world. In the diamond market, where the quality of diamonds can vary drastically and the customer base is not as diverse as is the case with gold and silver, I think such a strategy is particularly prudent.

Ultimately I'm not in a rush to get into the diamond market, and plan to study it more intensely before making any decisions. I do think, though, that diamonds could be one of the next big opportunities in the resource sector - and thus are worth keeping on the radar and studying more carefully.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.