The love trade is going in circles

It has been years since I looked at diamond prices--the same as true for cocoa.

Here in China, Single's Day has just passed--and it may be time to start thinking about Valentine's Day. With this in mind, let's consider diamonds and chocolate--two of the enduring commodities in the love trade.

Below I present a chart comparing the cocoa price (US$/tonne) against the RAPI index for 1-ct diamonds (or at least my best guess of it given the information at hand).

Since 2010, we have seen a big cycle, with our current position not far from where we started, with chocolate being relatively expensive, and diamonds relatively cheap*.

The cocoa price seems to be rising of late. There's no civil war in Cote d'Ivoire--this time, the culprit is the long-term lack of investment in cocoa plantations, combined with a fungus that has already killed about 30% of this year's global production.

Because of the coming chocolate shortage, I've been stocking up.

It's slow going though. The local chocolate is pretty bad, and the foreign stuff only comes in a bit at a time.

* As always, you should not view this as investment advice. Especially if you are buying for a special someone.

Waiting on the A-hole in J-hole

The idea for this title comes from here.

Looking for some action in the state space diagram for the gold-silver ratio.

We have been drawing the hook at the bottom of the graph for the past several months.

To look at how recent actions by the Fed might have influenced the gold-silver ratio, let's look at only the past few years of data.

Here we are looking at the evolution of the system over the past four years or so, from the trough in silver in late 2008. Remember that the vertical axis is lagged by a year, so, change in the vertical direction is a reflection of things that happened a year previously.

On this graph QE1 occurred right around the time when the gold-silver ratio stopped rising and began to decline. So it may have reversed the decline of silver. The spike in silver price (collapse in gold/silver ratio) at the far left of the graph occurred during QE2. So arguably, both QE1 and QE2 were relatively favourable for silver.

Operation Twist has had basically no effect on the gold-silver ratio (the vertical motion is a reflection of last year's fireworks). To see an effect by QE3 we would look for a large deflection to the left or right in the trajectory of our state space.

I can also attest a similar effect in diamond prices. Both QE1 and QE2 corresponded to significant increases in diamond prices. We have not had the same effect from Operation Twist (harder to graph as the specific diamond index data is no longer freely available).

We await the announcement coming tomorrow from Jackson's Hole. It is unclear whether there will be any substantial QE--what they have been doing through Operation Twist seems to have gotten the CBs what they want--some higher asset prices, but not commodities. For this reason, I wouldn't expect any announcement but either more of the same, or some kind of jawboning.

Extended price fall for diamonds--is QE3 on the way?

We have presented price info for diamonds previously, with particular attention paid to the impact of quantitative easing programs on diamond prices.

The price of diamonds has fallen more or less steadily since its peak in June of last year.

The price of the RAPI index for 1-ct diamonds is off about 15% from last year's peak.

The RAPI index for 3-ct diamonds was off nearly 2% in May alone, as compared to 1-ct diamonds which were down only about 0.5%. As the larger diamonds are in the $90,000 price range (which is a bit high for me), I interpret this as a sign that the well-heeled clients have spent the last of their bonus money and are in need of another bailout.

It may be worth repeating here that diamond exploration effort has fallen dramatically over the past few years--currently about 2.5% of (non-fuel mineral )exploration money is spent on diamonds--in 2006, it was 12%.

How QE2 helped Main Street, example 1: High-end diamond retailers

One justification for bailing out Wall Street was that it would ultimately help Main Street.  Last time we looked at the diamond price index for 1-ct diamonds. Today we investigate the effects of QE2 on that most Main Street of businesses--the high-end diamond retailer.

Below is a chart for the price of 3-carat diamonds (the RAPI index, based on the price of the best 25 diamonds of a given size, clarity, and colour).

At the prices quoted, a single diamond of this size would set you back about $110,000. Hopefully she's worth it.

There are two significant periods of rising prices--early 2010 (at the tail of the first QE), and November 2010 to June 2011, during which time prices rose about 30%. The official CPI (excluding food and energy) was 1-2% over the same interval. We note that this last interval corresponds approximately with the timing of QE2, and congratulate the Federal Reserve for aiding Main Street business.

In a related chart, we see that jewellry prices and sales rose through the first half of 2011.

In our next installment we will compile the caviar index and the well-known 100-year-old-port index to see how these Main Street retailers have been affected by QE2.

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.