Traders eye on diamonds after gold

DiamondWatchThe Securities and Exchange Commission is reviewing a proposal to create the first diamond-backed exchange-traded fund, which would be available to anyone with an online trading account.

Group of investment professionals across the globe are working hard to turn diamond into a commodity that would be available to investors. They are trying to trade the gem in the same way gold has been traded through fund on exchanges. So far, trading in diamonds is limited in the United States to the retail market for engagement rings and other jewelry and the back-room bargaining among merchants in places like Manhattan’s diamond district on West 47th Street.

However, financial industry players from New York, London, Switzerland and Israel say there is a scope for public access of investors who have been willing to invest money into funds backed by metals like palladium and silver. Those players have turned a gold-backed fund, the SPDR Gold Shares, into one of the world’s largest exchange-traded funds, with a market capitalization of about $70 billion.

The Securities and Exchange Commission is evaluating ways to create the first diamond-backed exchange-traded fund, which would be available to everyone with an online trading account. It would buy one carat diamonds and store them in a vault in Antwerp, Belgium, providing daily values with an as-yet-unnamed index. The fund is backed by a New York company, IndexIQ that has brought 14 other exchange-traded funds to market in the last five years. In addition, Martin Rapaport, who founded a popular gauge of diamond pricing, said recently that he was preparing to release a “few” products this year that would be available to retail investors. He declined to describe them.

In perhaps the most developed plan, the largest publicly traded diamond company, Harry Winston, is working with a Swiss asset manager to create a $250 million fund that is set to begin buying half-carat to six-carat diamonds this year with money from institutional investors like hedge funds and pensions. “Diamond is the last uncommoditized commodity, and so it’s drawing in many organizations,” said Edahn Golan, the editor in chief of IDEX Online, a provider of diamond industry data. “I assume that by the end of this year there will be a bunch of them out.”

Investment professionals say that retail investors should be very careful, given the difficulty of establishing consistent prices for diamonds of widely different cuts and quality, and the traditional secrecy of the industry. “There would be a huge learning curve for me to be comfortable trading something like this,” said Matt Zeman, a commodity trader at Kingsview Financial.

The diamond industry can only dream of replicating the success of gold companies. Gold investments, rather than jewellery, have become the primary driver of growth in the industry, according to the World Gold Council, pushing annual production to around $100 billion, Citigroup analysts say. By comparison, the annual production of polished diamonds is about $18 billion, Citi said.

The allure of diamonds is that, like gold, they are easily authenticated and long lasting. But unlike gold, and oil, diamonds have not had much price volatility, in part because they have not been touched by large flows of speculative money, though that could change if the new efforts succeed. “It makes sense that investors would have interest in diamond backed funds,” said Joung Park, a commodities analyst at Morningstar. This is not the first rush to bring diamonds to Wall Street. When inflation was soaring in the late 1970s, the search for stable stores of value led to a few legitimate, and many illegitimate, operations that lured retail investors into diamonds.

The market long repelled many investment professionals because of the 80% to 90% market share of production held by De Beers, the global diamond giant. That began to ebb when De Beers relaxed its grip on the supply channels in 2000, and subsequently sold some of its mines and inventory, reducing its market share to 40 percent today, according to Citi.

“Before De Beers gave up its monopoly, the investment case was pretty difficult,” said Peter Laib, chairman of the Swiss firm Diamond Asset Advisors, which is working with Harry Winston on a diamond fund. The end of the monopoly still left perhaps the biggest barrier to investment: the lack of uniform standards for diamond pricing. Unlike gold, which is sold for essentially the same price in financial markets around the world, diamonds have been sold mostly through bazaar like areas like the Manhattan district and the Antwerp Diamond Bourse, which advertises that a “binding handclasp fixes price, delivery and conditions.”

Many market participants argue that diamonds are not a commodity but unique items that need to be evaluated individually. But Wyndham, Rapaport and IDEX are competing to prove that wrong by creating standardized pricing. IDEX has an hourly updated index of asking prices from its online database, weighted with the 15 most popular varieties.

The IDEX index is not the best gauge, Mr. Wyndham argues, because it relies on asking prices rather than actual transaction prices, as stock exchanges do. He has built the Polished Prices index, which is available on Bloomberg terminals, and uses selling prices the company receives from 20 wholesalers. He said he was working with a “major European financial institution” that is seeking to win regulatory approval in Europe for yet another diamond fund that could be available to the public.

Polished Prices hosted a conference in 2007 with dozens of finance industry professionals who considered how to make diamonds a regulated investment. Mr. Wyndham’s partner, Richard Platt, said he thought then that a product would be available sooner.

Courtesy: ET