New Fund Will Add Greater Liquidity to the Multi-Million Dollar Stones Market
June 28, 07You can’t have your cake and eat it too. Faced with a considerable liquidity crunch, various parties in the diamond industry are making great efforts to draw in capital from the outside. These capital-raising efforts range across the board from derivatives, futures markets, securitization and hedge funds to other schemes.
There are many reasons for the lack of liquidity in the diamond industry, a major one being the higher return on equity invested in non-diamond industry opportunities. For a highly indebted industry, attracting outside money is crucial, if not critical. Diamond-industry financing institutions have a similar interest; outside money replaces banking credit.
Currently, some of my trade colleagues are promoting diamond futures with great enthusiasm as a welcome hedging instrument for diamantaires. The benefits to the industry are self-evident. However, a question must be asked: What is the benefit, or the investment opportunity, for the investor? After all, it is not easy to create uniform parcels of diamonds that meet stringent and consistent criteria. There are costs involved in valuations, insurance, certification, warehousing, actual delivery, etc. in addition to the costs inherent in trading commodities futures.
Do polished diamond prices fluctuate sufficiently enough to provide investors with meaningful returns beyond those of other commodities or alternative investments? While we recognize the benefits of futures to the trade and to the banks, we are less convinced about what the investor gains.
Aiming at the High End of the Market
The commoditization of diamonds is by now an indisputable fact. After more than a generation of certification, paper-based trading is ready for more sophisticated instruments. The demise of De Beers’ market control means the company is no longer in a position to exert meaningful control of (and thus frustrate) a futures market, as it would have been in the 1980s.
The new opportunities in diamonds were recognized by one of the largest commodity investment management firms, Swiss-based Diapason, which manages over $6 billion worth of investments in commodities. Diapason is now about to launch a diamond investment fund whose shares will be traded on the main list of the London Stock Exchange. This will be the first diamond-based, publicly listed fund that invests directly in polished diamonds as its physical underlying asset.
The fund, called Diamond Circle Capital, will be a closed-end investment fund with a target to raise $400 million. The Diamond Fund will only purchase individual diamonds valued at $1 million or greater, concentrating on the world’s rarest diamonds.
The market’s reaction to the Diamond Fund has been very positive and supportive toward the idea of a unique, relatively cost-efficient listed instrument that gives investors exposure to the diamond market. However, some corners of the diamond market have raised a few questions, mainly about pricing and liquidity, given that there are a very limited number of diamonds produced annually in this category. Similar questions could also be asked about prices in a futures market, such as when investors sell short, and when shortages prevent actual deliveries.
In my view, these specific concerns represent a great strength of the Diamond Fund’s formula. Diapason has deliberately identified the niche of diamonds in which price appreciation is greater. It has documented and recorded sales of large diamonds that have doubled in price in just a few years. The firm has identified the rarest and most spectacular stones in the diamond value chain where it believes outside investors can make the highest returns.
I recently prepared an independent market report for the Diamond Fund and, through this work, met the Diapason team who truly impressed me with their level of sophistication, understanding and professionalism. I also found notable the Board of Experts they have assembled, which includes some of the industry’s most experienced representatives.
Creating More Trading Liquidity
While the diamond industry is becoming more competitive, the specific niche market, where stones worth $1million to $50 million are traded, is controlled by a handful of major players, who are all easily identifiable. What makes these players so exceptional is that they can cut and polish a $15 million diamond and hold it in inventory for 10 or more years if they don’t find the right buyer at the right price. They can afford to “protect” and “defend” the value of the diamond.
But what of those who are not considered major players? There are dozens of good diamond manufacturers who will not even try to compete for the truly large rough stones because they cannot be sure that they have the right connections to immediately sell the resultant polished. They cannot afford to hold on to these goods. The Diamond Circle Capital Fund significantly widens opportunities for the trade to sell large polished stones.
Some of the current dominant players in the big stone market may not like this added competition, but it’s good for the business at large. If anything, it gives a very narrow market more liquidity rather than less.
The Diamond Fund will be an active player in the market, as a buyer and as a seller. To the banks, a player like Diapason is extremely significant. As a rule, diamond banks will not finance inventories! It is my understanding that in Belgium, the central bank may even have issued instructions to this effect. The Diapason fund will meet the requirements of a niche where there is very little bank financing available. It fulfills a vital need in the diamond business to the benefit of all sectors of the diamond market. A stronger “high end” of the business will usually follow through and lift prices in other categories.
The Diamond Fund is intended for highly sophisticated and long-term investors, many of whom will come from Switzerland, the Middle East and Asia. Indeed, some of the investors may also be the end-consumer of the very same product.
Fund May Drive Prices Up
One of the world’s largest manufacturers and dealers in expensive rare stones expressed unequivocal support for this new Diamond Fund. “Their valuations will be done by experts such as John Doyle Block, formerly of Sotheby’s, and Simon Teakle, formerly of Christie’s, whose respective 30 and 20 years of auction experience enables the correct pricing of unique stones. The Diamond Fund, if it holds eventually some $400 million worth of the largest stones in the business, will, in fact, become the price setter in this small highest value niche. Their transparency will help drive up prices.”
“Diversification is also important,” commented the diamantaire. The Diamond Fund will invest 60% of its funds in large white goods and 40% in fancy colors. “In any year, there may be only two stones in excess of 100 carats on the market. Large blue and pink stones are often simply unavailable. A balanced portfolio will be very attractive to investors who do not want to own a specific size or color.”
Hitherto, except for some auction results, there has been hardly any transparency in the pricing at the highest end of the diamond spectrum. “Prices based on specific reports by traders to price lists tend to be influenced by concern about taxation and other external considerations. The Fund will report true transaction prices on both the trade and consumer levels. It will be refreshing to have such prices available on the market,” noted another dealer.
This dealer dismisses comparisons with the early eighties, when the public at large (housewives, teachers, etc.) invested a few hundred or thousand dollars in funds that needed to liquidate assets when the public panicked. “The multi-million dollar stones market consists of sophisticated long-term players. These stones will always remain rare. If an investor wants ‘out,’ he’ll sell shares – there is no need to sell stones. The fact that there is no link between investors selling and the sales of stones insulates the Fund against ill-founded fears of ‘liquidation sales,’” added the dealer.
When a new product is launched, anxiety or discomfort from within the industry is understandable. But here lies the contradiction: The industry likes to have outside investors. It needs their money. However, when outside investors actually identify a niche for a good investment, while also providing tangible benefits to the trade, it seems the industry gets nervous. As I said at the beginning of this editorial, “you can’t have your cake and eat it too.”
The Diamond Fund and Diapason formula presents a “win-win” situation. It is good for the industry and provides a good opportunity for investors. Not everybody is happy that diamonds have been commoditized – but they have. This is bound to attract commodity investors into the business. We should consider ourselves lucky that the first major commodity investment player to come in is professional and experienced – it will stimulate others to follow and will instill confidence in diamond investments.