The price of diamonds has always seemed opaque and subject to price manipulation by producing countries or purchasing houses who controlled the flow of diamonds into cutters, polishers and jewelry manufacturers. Regulators have always seen the diamond market as not a suitable investment for the modest investor. The idea of any large transportable financial asset, where $100MM dollars fits within a very small package has always been a large concern to government officials.
Prior to Basel III and Dodd-Frank regulations diamond merchants could easily finance large inventories of diamonds at a high percentage of their market value. The same market value as set by the diamond merchants. However, this is not the case any longer. Today the financing percentage on diamonds are less than half of the haircut percentages prior to the adoption of these regulations. Today stocks and bonds are traded in regulated public markets on exchanges or electronic markets, where trading prices can be collected, published to market participants, and made available to all investors. In the late 1800s and early 1900s the stock market in the U.S. experienced much of the same negative fundamentals that the diamond market is viewed today.
Diamond producers and jewelry consumers will need to change investor perception of the global diamond market and adopt the path of equity markets and their regulators to produce: transparent trade prices, regulated pricing platforms with actionable bid/offer prices, and the distribution of market prices to third party media distributors. The Dow Jones Industrial Average, the first U.S. market index of note, was based upon closing prices of 30 stock prices and it provided a key benchmark for market and investor performance. The prices of the 30 constituent stocks were made public and the index calculation method, the sum of the closing prices divided by 30, disclosed to the marketplace, in order to permit third parties to replicate the index’s value.
The same market infrastructure needs to be achieved for diamonds if they are to become investable. Futures, equity prices, OTC and listed derivatives and all such investor tools need to be captured and derived from real time bid/offer diamond trading prices. The diamonds that makeup the market index value must be representative of the global diamond marketplace seeking to finance diamond stone inventories and migrate diamonds into the financial marketplace.
Diamond merchants will want to foster the creation of diamond depositories and listed financial securities, based on actual bid/offer diamond prices if diamonds are to transition from gemstones to the public markets. But unlike gold, silver or commercial metals that are refined to a specific purity standard, diamonds occur naturally, and therefore their impurities and imperfections become a matter of skilled analysis using defined market diamond rating standards. There is currently an individual gemstone market in Singapore, but its’ focus is based on single stones. Unfortunately, as no two stones are identical and therefore the unit of measure needs to go beyond one stone and must be a measure of some size so that the securitized quantity can be “normalized” into a uniform trading unit for investment. The unit must be large enough to be normalized, but not so large as to prevent market making, the holding of inventory positions, or the ability to secure insurance coverage on the trading unit. By establishing a fixed unit of many diamonds, investors will have a measure of price increase/performance. Without this fixed unit size the issue of performance, on one stone, could be too subjective and the foundation of measure subject to manipulation. The cost of manipulation of $100s of billion in diamond assets from the primary and secondary markets would be beyond the control of any diamond producer, group of diamond producers, or group of jewelry manufacturer. This will be a key fundamental for the diamond market in the years to come.
The creation of diamond depositories, that bring diamond inventory into approved depositories, using a single standard of diamond value assessment, will promote investor confidence currently exhibited by custody depositories where notations of stock positions can be verified and audited annually by public auditors. If diamonds are to become investable assets, regulators will need to help establish a set of custody guidelines that the diamond market must adopt to migrate diamonds from the obscure gemstone market to equity exchanges.
ETFs, backed by physical diamonds supported by in-kind creation and redemption of a diamond Unit can be adopted by the ETF marketplace. The public prices of the diamond constituents and their composite indexes will prove to be the source against which commercial lenders can finance diamond inventory during the cutting and polishing process, at market haircuts established by these new laws. Diamond backed ETFs would provide a regulated means to settle exchange trades, and provide incremental investor income to a non-income generating security. Physical backed natural diamond ETFs would transform this opaque market, provide suitable financing standards for commercial lending, jewelry inventory financing; and investors looking to transition diamond investments into the public investment sector.
The sector will require oversight by regulators. Diamond rating organizations, like the GIA, could provide a single set of diamond rating standards accepted globally. Excellent custodial controls, and participation from the service provider community will build investor confidence in this new asset class. This diamond asset class increases annually in excess of $25 billion dollars in new diamonds inventory mined, cut, polished and used for jewelry and investments. Like gold, the existing inventory of secondary diamonds available to the marketplace far exceeds the annual production that would be available for investment inventory.
As no two stones are identical, the unit of measure needs to go beyond an individual stone and therefore must be a measure of some size so that the securitized quantity can be equalized into a uniform trading unit for investment that represent the diamond market. The unit must be large enough to be equalized, but not so large as to prevent market making, the holding of inventory, or the securing of insurance coverage on the trading unit. By establishing a fixed ETF Unit, investors will have a measure of price increase/performance. Without the fixed unit size the issue of performance could be too subjective and the foundation of measure subject to manipulation. The cost of manipulation of $100s of billion in diamond assets would be beyond the control of any diamond producer, group of diamond producers, or single jewelry manufacturer.
Prior to Dodd-Frank, Basel III and many other government regulations, diamond producers could withhold rough diamonds from the market, but today each diamond producer can’t afford to do so by policy and their inability to finance this inventory under the banking regulations. However, government policy and the diverse source of diamond production has broken the historical consortium control of diamonds into the global diamond market. Additionally, the growth of industrial diamond usage has increased the overall participants in the diamond marketplace. Conflict diamonds are a major concern to the diamond industry and diamond rating companies, like the GIA, can identify conflict diamonds based upon their composition. The greater challenge for the diamond rating companies is the growth of synthetic, man-made, diamonds. The manufactures of these synthetic diamonds can produce diamonds with no impurities, but also diamonds with the same impurities as known diamond ore bodies. Thus there is difficultly in separating synthetic diamonds from the naturally occurring diamonds in the marketplace. The GIA, and other rating services, have developed improved technology to discern these diamonds from natural diamonds and will exclude them from the ETF Unit.
The value of synthetic diamonds is less than natural diamonds and for investor confidence each ETF Diamond Unit created must be certified by an approved rating company, sealed, numbered and held by an authorized diamond custodian. No sealed or numbered ETF Units should be destroyed as it would bring into question all of the diamonds held within the ETF Unit. Any Unit where the seal is broken must be resubmitted to the GIA and recertified prior to being included in any ETF Unit under a new Unit seal. Investor confidence in the chain of custody and rating standards, uniformity of standards, and third party audit of the ETF diamond inventory will be a cornerstone to the success of the diamond ETF.