Diamonds May Be Forever, But Are They Investments?

Affluent investors are looking for an inflation-fighting commodity other than gold, and in finished diamonds, they may have found one.

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“Better a diamond with a flaw than a pebble without one,” goes a Chinese proverb.

That’s increasingly the mindset for investors — especially wealthier ones — seeking hard assets in the face of the ongoing market turmoil. With gold climbing to record highs in the past year — it topped $1,800 per ounce this week — many investors have been looking to diamonds as a viable alternative. 

In fact, diamonds actually outperformed other commodities in 2010, according to Saul Singer, a partner at the alternative assets investment firm Fusion Alternatives, which specializes in diamond investments. Says Singer:

“Many might remember 2010 as the year global commodity prices continued to surge. The Dow Jones-UBS Commodity Index ended the year up 36 percent. Strong gains were experienced across all major commodity markets with the industrial metals market leading the charge. Investment diamonds gained 20 percent in 2010, however on a risk-adjusted basis, Investment diamonds outperformed even the surging commodities market.”

The U.S. consumer price index for jewelry – yes, a CPI for jewelry – jumped by 11.9% on a year-to-year basis in July to a record of 176.46. That’s the seventh-straight month that the index climbed above the 170 level.

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De Beers, one of the world’s biggest diamond companies, says that while the increase of diamond prices was limited to 7% in the U.S. last year, spikes in China (26%) and India (37%) were much bigger and have continued in 2011. Not surprisingly, higher diamond prices and increased demand have boosted global diamond stocks as well. “We’ve seen much more demand than we can supply, especially for very expensive diamonds, which is where we operate,” noted Gem Diamonds Ltd. Chief Executive Officer Clifford Elphick in an interview with Bloomberg Friday. “We expect a pause in the rise in diamond prices. It is unlikely that prices will continue rushing ahead as they’ve done in the past year. But then it will get back in its upward phase.”

The higher prices haven’t stopped the uber-rich from trying to grab as many high-quality diamonds as they can. In an interview with CNBC Friday, Henri Barguirdjian, CEO of luxury jewelry Graff Holdings, said that burgeoning interest in diamonds as an investment is a relatively new phenomenon:

This is something that has never happened before. We are being approached by money managers of very wealthy clients, or the wealthy clients themselves, who are all considering investing a small percentage of their portfolio in diamonds. This is something we have never seen in the past. These people never considered diamonds as an investment. … They considered them as something very beautiful and nice to own, it made their wife happy and it’s gorgeous to look at but they always neglected the financial aspect of the transaction. And now they see what has happened with the price of diamonds and they realize it is not so much a silly idea.

He added that some Forbes 400 types are investing up to $100 million in the diamond market these days, mostly favoring “finished” diamonds over rough ones. He says that affluent investors are starting to view diamonds as a great inflation hedge and as a low-maintenance investment that is traded all over the world.

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Of course, Barguirdjian has a vested interest in the idea of diamonds as an asset class and not just as pretty baubles. In his comments, he perhaps inadvertently hinted at the risks of this largely untested investment idea — and the reason that ordinary investors should probably tread carefully there, if at all. “Financial institutions are seriously studying the diamond market,” he said. “We have been getting lots of calls by people who are doing reports on this and they want charts and price history so they can formulate their research.”