Investing in Diamonds: The Terms of Engagement

Buying diamonds as gifts and as jewelry is a common practice, but investing in diamonds is not for the average person. After all, the most economically feasible diamond …

Buying diamonds as gifts and as jewelry is a common practice, but investing in diamonds is not for the average person. After all, the most economically feasible diamond investments still require access to a tremendous amount of capital and high tolerance of risk.

Diamonds have been notoriously difficult to sell on the resale market at a profit; in order to make money, diamond investors need to find a buyer who is willing to pay more for their stone than they did. Nevertheless, diamond investments are being viewed as increasingly attractive as a result of recent trends that suggest a diminishing global supply.

Multifaceted investments

Diamonds carry unique attributes that distinguish them from other types of investments. As a highly concentrated asset, diamonds are extremely portable and easy to have on one’s person at all times as jewelry or loose stones. Investing in diamonds also carries benefits of financial privacy and complete ownership.

Diamond values are not directly linked to stock and bond markets. Diamond prices have increased an average of 15 percent each year since 1949, according to statistics published by diamond manufacturer Ajediam on their company website.

“Diamonds do hold their value well,” Chuck Jaffe wrote in his syndicated column last December. “So long as the stone is real, it’s not going to zero like a company headed for bankruptcy.”

International demand for diamonds appears to be on the rise, especially as an increasing number of high net worth individuals emerge in the Russian, Middle Eastern and Asian markets. The emerging middle class in China is expected to create a sharp increase in demand for diamonds and other luxury goods, according to an article in The Financial Post last June.

Extremely rare stones seem to carry the highest potential for strong performance and returns. The values of colored diamonds, for instance, have roughly doubled every six to seven years during the past 35 years, Stephen Hershoff, senior executive and managing director at Pastor-Genève, said in an e-mail interview.

Furthermore, “the colored diamond market has always been an asset class that has held its value during recessions and economic downturns,” he said.

Colored diamonds are exceptionally scarce when compared to the white variety; in terms of natural supply, the ratio of white to colored stones is approximately 10,000-to-1, according to an article posted on the Pastor-Genève website last October.

Investing in diamonds, however, is a high-risk endeavor. Regardless of the quality and appraised value of the stone, an investor’s ability to reap a profit is at the mercy of what a buyer is willing to pay.

“Diamonds are appraised and graded, but prices move based on consumer sentiment,” Jaffe wrote.

Diamonds are not especially liquid, and an investor who wishes to sell his or her diamond in order to obtain quick cash can suffer enormous losses.

“Dealers who buy jewelry don’t pay retail, and the nation’s pawn shops are full of expensive gems that were turned in for a lot less cash than they were purchased for,” Jaffe wrote.

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Even colored diamonds “take some time to sell,” Hershoff said.

“There are no specific bids and offers on a daily basis,” he said. “It is more like art, coins or land  in that you have to watch for similar sales to get an idea of price performance.”

If diamonds are bought at retail prices—generally two to three times more than true wholesale prices—there is “no shot” of selling them for a profit for at least a decade, Jaffe said.

And as a highly concentrated and portable asset, diamonds can be easily lost or stolen without proper security measures.

Recent history serves as a cautionary tale about the potential for diamond scams. In the late 1970s, a large number of fraudulent investment firms engaged in a phone campaign to sell mail-order diamonds, according to a chapter in The Diamond Invention by Edward Jay Epstein. In addition, many of the firms held diamond-investment seminars in expensive hotels and sold sealed packets of diamonds to the audience.

Although the sealed packets distributed through seminars and by mail included certificates guaranteeing the quality of the diamonds—so long as the packets remained sealed—buyers were in for an unpleasant surprise.

“Customers who broke the seal [in order to verify the quality of the diamonds] often learned from independent appraisers that their diamonds were of a quality inferior to that stated,” Epstein wrote. “Many were worthless.”

In general, investors who know little about diamonds and how to buy them can be especially ripe targets for unscrupulous dealers.

Mining the diamond market

Diamond investments are often met with pessimism and, at times, downright condescension. Jaffe, for instance, wrote about diamonds in his syndicated column, titled Stupid Investment of the Week, last December. Diamonds may provide a terrific return as an “investment in emotion,” but “try to cash in a diamond for a profit and you have all sorts of trouble,” he wrote.

But is investing in diamonds as imprudent as it sounds? Counter to what the skeptics might expect, institutional investors are beginning to enter the diamond investment market. Swiss firm Diapason Commodities has been raising money for the launch of its Diamond Circle Capital product, according to an article published in Investment Adviser last June.

The fund will only buy polished diamonds worth more than £506,000, or approximately $1 million. The product will be the first London Stock Exchange listed fund to invest in diamonds and trade them on the secondary market.

The state of the diamond market is even more compelling.

“Diamond supply is declining for the first time in 30 years and it is primarily happening in areas where they find rare colored diamonds,” Hershoff said.

The leading mine in Australia, which produces 90 percent of the world’s pink diamonds, saw a drop of 30 percent last year in supply, he said. An additional decline of 20 to 30 percent is expected for this year.

“Pink diamonds are becoming more and more difficult to source, which is putting tremendous upward pressure on prices,” he said.

In addition, the balance of supply and demand for diamonds—and consequently, their pricing—is no longer artificially controlled by the DeBeers company, which historically owned more than 80 percent of the market.

“DeBeers is no longer the controlling factor that it once was 30 years ago,” Hershoff said. “[Their] market share has dropped to just over 40 percent of world supply; they have sold off their stockpile, and missed out on new discoveries in Canada, Australia, Russia and Central Africa.”

How to invest in diamonds

Diamond investments are probably not suitable for most investors because of the amount of capital required.

“The new breed [of diamond investors] are probably already millionaires and—unlike the majority of normal investors—able to shoulder losing up to £50,000, the minimum you would spend on investment diamonds,” according to the article posted on the Pastor-Genève website last October.

There are ways to mitigate the risk of enormous losses, though. If investors decide to buy, they should follow two basic rules: first, they should buy diamonds at wholesale or near-wholesale prices; and second, they should only buy diamonds that have been internationally certified by one of the major gemological laboratories, such as the Gemological Institute of America (GIA).

Investors should try to obtain stones that are as rare as possible, such as stones of the colored varieties. By virtue of their rarity, colored stones are comparatively easy to pass on and are “consequently popular investments,” according to the Pastor-Genève website.

It is important that colored diamonds are natural stones as opposed to synthetic creations, according to Hershoff. Synthetic colored diamonds are much more abundant and priced much lower than their authentic counterparts.

Investors should also be wary of buying uncut stones, which can be “extremely risky,” Hershoff said.

“The difference in value between the colored diamond grades once the stone is cut and polished can mean tens and even hundreds of thousands of dollars per carat,” he said.

Because sales are largely unregulated, “finding a reputable broker is key,” according to the Pastor-Genève website. Performing due diligence on potential brokers can help protect an investor from abuse by unscrupulous individuals.

As is the case for any type of investment, investors should educate themselves as much as possible about diamonds and what factors could potentially affect their values.

When speculated properly, diamonds may prove to yield decent performance as medium- or long-term investments. However, a successful diamond investment will probably require the ultimate luxury: time.

“Most investors look at holding periods of at least five years,” Hershoff said. “When they do look to sell they allow a few months to broker the stone, whether at auction, at the dealer level, through trade shows or to retail buyers.”

Retail diamond prices are continuing to trend upwards but profitable margins on resale remain largely unproven. Still, if demand outstrips supply as industry experts predict, then diamonds present an enticing—though risky—opportunity for investment.

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