Dust flux, Vostok ice core

Dust flux, Vostok ice core
Two dimensional phase space reconstruction of dust flux from the Vostok core over the period 186-4 ka using the time derivative method. Dust flux on the x-axis, rate of change is on the y-axis. From Gipp (2001).

Sunday, September 11, 2011

Diamonds as investment since 2009

Every few years, my name comes to the top of a list somewhere and an impressive-looking package arrives in the mail from an outfit called Pastor-Genève B.V.B.A. In it there is always a glossy newsletter explaining why diamonds are a superior investment. No doubt the Company's motto is: "Everyone should have a couple of hundred thousand dollars invested in diamonds."

And yet within their literature one can discern many of the reasons why diamonds are not a good investment. Many of these reasons may be found here, but they can be summarized as illiquidity, non-fungibility, non-divisibility, and the difficulty of valuing a diamond in the field (or in the marketplace). One statement from the literature which supposedly states reasons for investing in diamonds:

In a market where pricing is a closely held secret, tied to the absolute uniqueness of most colored diamonds, the auction market provides a stunningly open price venue.
Really. That makes me feel much better about not having any predictive power over the price I might receive for my investment.
Potential buyers form an ever-growing market that seems to have no limit.
I've heard that one before, usually from an advisor just before something starts to go down.

Can diamonds be a good investment? I remember reading something about the diamond exploration business when I was an undergraduate geology student. On the topic of colour, the consensus at the time was that "brown" diamonds were only suitable for industrial use. A couple of years ago, the Pastor-Genève newsletter discussed the growing demand for "champagne" diamonds. I looked at the pictures and realized these were the same brown diamonds previously considered worthless; now rebranded and advertised at a premium.

Just how does this work for an investment. Imagine you buy shares in Worthless, Inc., and one day, after relentless advertising, the company turns into Apple and the shares are worth a fortune. Alternative scenario--you buy shares in Enron and overnight it becomes Worthless, Inc. It is one thing if such a change happens due to fundamental changes in the operations and finances of the company. It is entirely different if the change happens simply because some analysts or media talking heads promotion.

We can assess the performance of diamonds as an investment by inspecting the RapNet Diamond Index (RAPI) for 1 carat polished stones.

The index is the asking price, in hundred of dollars per carat, of the best 25 round 1-ct diamonds within a certain range of colour and clarity. Your diamonds may be worth more, or less, depending on factors too numerous to belabour here. Also, the spread is unknown, but understood to be considerable.

Data availability isn't the greatest. Actual numerical index values are only given for the past three or four months--the remainder of the curve has been reconstructed from monthly percentage gains. The errors tend to compound, so the older portions of the curve may have significant inaccuracies.

The industry reports suggest that the rapid rise in diamond prices was the recovery from the falling prices that occurred since 2007. We cannot comment as we weren't looking at diamond prices at that time. The rapid increase from last December until June of this year looks suspiciously like the timeline for QE2.

Below we see a graph of the gold/diamond ratio over the same timeframe.

I have used the price for an ounce of gold (closing price) against the RAPI index price from the graph above. Where values are rising, gold is rising in price faster than diamonds, and vice versa. Form our limited data set, it appears diamonds were a better investment than gold during QE2, but not at other times. 

What does this tell us? During episodes of Quantitative Easing, the inflation trade wins out. Diamonds have historically helped preserve wealth during inflationary or hyperinflationary episodes, despite their lack of liquidity. In this case I wonder whether the market for investing in diamonds had more available money during QE2 than at other times.

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For myself, I only invested in diamonds once--shortly before getting married. The returns, while satisfactory, are difficult to quantify.

1 comment:

  1. Diamonds are very common. They are held by a cartel which warehouses great quantities. Marketing makes them look attractive. The market could be flooded at any time. A fool and his money are soon parted.