The Diamond – A Timeless Asset in Portfolio

 

The Diamond – A Timeless Asset in Portfolio

The sentiment of diamonds being considered "investment pieces"; seldom echoes through occasions like engagement rings, Van Cleef necklaces, or milestone gifts such as a Cartier Love bracelet. While these acquisitions may seem exclusive to the privileged, their allure extends to all as timeless, cross-generational, family heirlooms that endure the test of time. Beyond sentimental value, investing in diamonds deserves recognition as a crucial element in marking life's significant milestones.

A seemingly modest 2 or 3-gram high-quality diamond can hold a value equivalent to 100 kilos of gold. This remarkable combination of value and portability positions diamonds as a potential form of emergency funding. Throughout history, populations displaced by war or extreme upheavals have successfully utilized diamonds as a portable and reliable asset in times of crisis.

Diamond Producers:

Diamonds are distributed across more than 35 countries globally. The primary contributors to diamond production are Africa and Russia, which collectively account for a significant share of the world's diamond output. Africa, in particular, is home to numerous diamond mines and plays a central role in the global diamond industry.

Canada and Australia are also significant players in the diamond production landscape. Both countries have made substantial contributions to the global diamond market, with mining operations that yield high-quality diamonds. Canada, in particular, has become renowned for its ethically sourced diamonds and is a key player in the industry. Regions in the Americas are also actively involved in diamond production. Brazil, in particular, has emerged as a smaller but noteworthy source of diamonds.

Diamond Characteristics:

Diamond, a solid form of carbon, exhibits a crystal structure known as diamond cubic, endowing it with the highest hardness and thermal conductivity among natural materials. The extreme rigidity of the diamond's atomic arrangement  exposes it to contamination by few types of impurities, with exceptions like boron and nitrogen. Infrequent defects or impurities, occurring at about one per million lattice atoms, impart colors such as Blue (Boron), Yellow (Nitrogen), Brown (Defects), Green (radiation exposure), Purple, Pink, Orange, or Red. Additionally, diamond boasts a remarkably high refractive index and relatively high optical dispersion, contributing to its unique and captivating visual properties.

Classification of Diamonds:

Diamonds can be broadly classified into two main categories: (1) Natural Diamonds and (2) Synthetic Diamonds.

Natural diamonds are those formed through natural processes or events. The majority of natural diamonds boast ages ranging from 1 billion to 3.5 billion years, originating at depths between 150 and 250 kilometers (93 and 155 miles) within the Earth's mantle.

On the other hand, Synthetic diamonds can be cultivated either from high-purity carbon under high pressures and temperatures or from hydrocarbon gases through chemical vapor deposition (CVD).

Additionally, Imitation diamonds can be crafted from materials such as cubic zirconia and silicon carbide.

Distinguishing between natural, synthetic, and imitation diamonds is commonly achieved through optical techniques or measurements of thermal conductivity. This classification not only highlights the diverse origins of diamonds but also underscores the importance of accurate identification in the diamond market.

The 4Cs of Diamonds:

Diamonds are assessed based on four key criteria, commonly known as the 4Cs, which play a pivotal role in determining their quality and price: Carat, Color, Clarity, and Cut.

Carat: Carat measures the weight of the diamond, with one carat equivalent to 0.2 grams. This metric is integral to the overall value of the diamond, influencing its price and highlighting its rarity. It's crucial to note that carat weight is distinct from diamond size, as different gem materials can have varying densities.

Color: The color of a diamond indicates whether it is naturally clear or exhibits a different color. Generally, the rarer the color, the higher the diamond's value.

Clarity: Clarity refers to any imperfections that may detract from the visual appeal of the diamond. Blemishes and inclusions are factors that reduce a diamond's clarity score.

Cut: Cut refers to the style or design used in shaping a diamond and encompasses symmetry, proportioning, and polish. Each diamond is unique, making them exceptional investment assets. The cut, with its unique facets, influences how much the diamond sparkles or reflects light, consequently impacting its price. To assess quality, diamonds are evaluated based on symmetry, polish, brilliance, and fire, categorized as poor, fair, good, very good, and excellent. Poorly cut diamonds may appear dull, significantly decreasing their value.

Diamonds possess high value density, allowing for easy transportation at a fraction of the cost of precious metals. The diamonds within a Diamond Standard Bar and Coin, for instance, are valued at around $1 million per ounce. However, value density varies among diamonds; for instance, a 1-carat Red diamond may be more value-dense than a 1-carat White diamond due to the rarity of Red diamonds. Diamond Standard's efforts to standardize diamond commodities enable investors to bridge the value gap by acquiring fungible Coins and Bars. This standardization helps eliminate disparities in diamond value, providing a more equitable investment platform.

An Underallocated Investment with Pent-Up Demand:

Investors currently maintain a significant presence in various precious metal markets, with substantial allocations of approximately 30% in the gold market, 19% in the silver market, 17% in the platinum market, and 15% in the palladium market. In stark contrast, the diamond market remains notably underallocated to investors, constituting only around 1% of their portfolios.

The underwhelming investment in diamonds, despite their well-established reputation as one of the most sought-after and valuable precious resources, becomes particularly perplexing when considering the substantial allocations in other precious metals. The lack of awareness regarding standardization issues further complicates this scenario, making it challenging for investors to tap into the diamond market. Each diamond's unique characteristics and individual price tags, in the absence of standardization, create a hazy path to liquidity.

The absence of a streamlined market structure  has hindered diamond price discovery and transparency, deterring potential investors from entering the market. Efforts to establish organized exchanges and market standards could potentially unlock the pent-up demand for diamonds and bring about a more robust and accessible investment avenue.

An Uncorrelated Asset for Portfolio Diversification:

Diversification stands as a cornerstone for risk mitigation within any investor's portfolio. By holding assets with low correlations, investors can effectively reduce portfolio risk. The correlation between two assets directly influences the resulting portfolio volatility, making it essential for savvy investors to maintain a diverse mix of assets with low or negative correlations. This strategic approach maximizes returns for a given level of non-diversifiable or systematic risk.

Diamonds emerge as a unique and uncorrelated asset class, exhibiting low correlations relative to multiple other asset classes. This characteristic suggests that diamond prices are influenced by independent drivers different from those affecting more frequently traded assets. The potential benefits of adding diamonds to a diversified portfolio become evident in the lower volatility they may contribute, given their distinct market dynamics.

However, it is important to note that the correlation of diamonds may experience changes, particularly with an anticipated increase in investor holdings. The advent of standardized and regulated diamond investments, coupled with a growing acceptance of diamonds as an asset class, could lead to an increase in correlation. Investments tied to diamonds, such as commodities, futures, options, private funds, exchange-traded funds, and commodity indices, may link a portion of their market price performance to overall demand for assets and securities. Consequently, heightened periods of market volatility could contribute to an increase in correlations between diamond investments and other assets.

Among the various diamond indices, the 1.0 carat mixed diamond index has shown the most effective risk-reducing performance. The construction of these indices considered different weights (0.3, 0.5, and 1.0 carats) and quality classifications (fine, commercial, and mixed) to reflect the diverse grades and applications of diamonds within each class. Investment-grade diamonds are further categorized into three size groups (0.3, 0.5, and 1.0 carats) and then classified by color and clarity.

Only colorless or near-colorless diamonds (grades E, F, and G) and specific clarity grades (VVS1, VVS2, and VS1) were used for these indices, with the rarity of apex clarity grades (FL and IF) and color grade D warranting a separate grouping. This meticulous categorization ensures a nuanced approach to including diamonds in investment portfolios, recognizing their potential as an uncorrelated asset for effective diversification.

High Price Volatility of Rough Diamonds:

The global financial crisis marked a period where rough diamond prices experienced significant volatility. Despite sustained consumer demand for polished diamonds, rough diamond prices plummeted by 50% as retailers, wholesalers, and manufacturers opted to sell down existing inventory rather than risk replenishment in an uncertain market.

Interestingly, 18 months later, rough diamond prices more than doubled, surpassing pre-crisis levels, driven by the industry's rush to restock in response to continued consumer demand. The expectation is that such pronounced volatility will persist, offering attractive trading opportunities for qualified investors who can navigate the market's fluctuations.

Single Stone Investment:

In a broader analysis, Low, Yao, and Faff (2015) identified 1.0 carat flawless diamonds as a strong hedge and a safe-haven asset. Notably, during the 2008 global financial crisis, these diamonds experienced the least volatility, with 1.0 carat flawless diamonds even rising in price when financial markets collapsed. The authors concluded that physical diamonds demonstrated satisfactory performance during periods of market volatility and should be included in a portfolio for their downside hedging potential. Top-quality flawless diamonds exhibited a strong negative correlation with international equity markets, making them an attractive store of value that can provide price stability and potential appreciation during market turmoil.

Larger and rare stones, resembling the high-end art market, carry characteristics of infrequent trades and unique pricing determinants, resulting in greater variability in outcomes and risks. Despite this, larger stones offer store-of-value characteristics and diversification benefits. The introduction of standardized exchange trading methodology on the SDiX platform enhances the recognition of diamonds as a rising asset class.

Industrial Applications of Diamonds:

Diamonds, renowned for their beauty, are equally valued for their exceptional hardness, making them indispensable in various industrial applications. The abrasive industry extensively utilizes diamonds for cutting, drilling, and grinding rigid materials. The growth of the construction industry has further intensified the demand for industrial diamonds, playing a crucial role in cutting, drilling, polishing, and grinding materials like glass, concrete, and ceramics.

Challenges of Cost and Price Volatility:

Despite the growing demand, the diamond market grapples with challenges related to cost and price volatility. The high cost associated with diamond extraction and the inherent uncertainty in natural diamond prices have left a notable impact. However, the market has seen a surge in lab-grown synthetic diamonds, offering a more cost-effective alternative. Price fluctuations in the diamond industry are influenced by factors such as consumer perception, rough diamond production, currency fluctuations, and evolving consumer buying patterns.

Cost of Carry:

The cost of carry for diamonds is defined as the expenses associated with storing a physical commodity or holding a financial instrument over time, is notably favorable. Carrying charges include insurance, storage costs, interest charges on borrowed funds, and related expenses.

Unlike traditional commodities such as oil and metals, diamonds have a fraction of the cost of carry due to their size and handling process. This advantageous cost structure, coupled with ease of storage and transport, distinguishes diamonds from bulkier commodities and adds to their appeal as an investment.

Future of Diamond Industry:

Continuing the trend of the past decade, the future demand for gem diamonds is anticipated to surpass global supply, leading to potential price increases. Existing mines, having surpassed their peak capacity levels, are facing increased production costs as they transition from open-pit to underground mining, and navigate stricter environmental regulations. The industry consensus is that no major new mines will be developed and operational in the medium term, given the considerable lead time of 7 to 10 years required to open a new diamond mine.

On the demand side, the United States maintains its position as the largest retail market for polished diamonds. Notably, China and India have surpassed Japan in recent years, with China emerging as the second-largest market for polished wholesale diamonds. The rapid expansion of retail jewelry stores in China underscores its growing significance in the global diamond market.

In the context of broader market dynamics, investors have witnessed volatility not only in listed stocks but also, in tradable forms of precious metals and commodities traditionally considered safe havens, especially following the last recession. In response to this, investors are increasingly seeking attractive, tangible assets characterized by low volatility and low correlation to other major asset classes, offering potential inflation hedging benefits. The heightened investor sensitivity to valuation characteristics has fueled a growing appetite for assets such as physical diamonds, where prices are fundamentally driven by real supply and demand dynamics. This shift reflects a strategic move towards assets perceived as more stable and grounded in tangible market fundamentals.

Conclusion:

The diamond market has witnessed significant developments, including the introduction of blockchain-backed diamond source platforms by major players like the De Beers Group. This technology ensures tamper-proof source assurance, enhancing transparency and traceability in the diamond supply chain.

Looking ahead, the diamond market is poised for steady growth. Factors such as increasing demand from millennials, expanding industrial applications, and technological advancements are expected to drive market growth. However, challenges related to cost and price volatility persist.

In the realm of investments, the polished diamond industry continues to evolve with a focus on increasing transparency, particularly as wealth accumulates in emerging markets. Diamonds, as precious commodities, serve as a store of value and a hedge against inflation. Currently representing only 3% of annual production, diamonds as investments have substantial upside potential in comparison to gold (40%) and silver (20%). The inherent rarity of diamonds further enhances their attractiveness as investments and valuable additions to diversified portfolios.

Author

Thakur Ajit Singh
Founder - Quick Turtle | Graded Financial Services | AskCred
Financial Expert | Trainer | Management & Placement Consultant
Cell: 8169810833