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Take a product that is difficult and extremely costly to locate, mine and bring to the market, while sources of that product are drying up and new mines take years to bring on stream and, generally, are on a relatively small scale. At the same time, demand from major emerging markets is continuously pushing the price of the product higher.

 

Surely from the point of view of an investor, seeing volatile global stock markets, governments in crisis, and the threat of a double-dip recession and disinflation, this would appear to be a classic investment opportunity? Indeed, investing in diamonds is increasingly being considered as following in the footsteps of gold, providing a worthy investment opportunity and a safe investment haven.

 

As a result, groups are being established to provide investors, nervous about the state of global stock and bond markets, with both an alternative investment option, as well as benefitting from rising demand and prices for diamonds. Indeed, despite the recent decline in prices for both rough and polished goods following the sharp rises seen in the first half of 2011, analysts still believe that investor interest in diamonds will continue to grow, largely as a result of the supply shortfall that is expected to be felt in the coming years.

 

RBC Capital Markets analyst Des Kilalea said that in general terms the long-term trend for diamond prices was to go higher which would be positive for diamond funds. "Currently, there is something of a downturn in prices and volatility which could be expected to be a little negative for such funds, but long-term the outlook is good."

 

Meanwhile, another analyst said that the dip in prices could be a good opportunity for investors to get into funds invested in the market. "In the same way that some more aggressive investors see falls in stock prices as a good time to invest, the same case could possibly be made now for getting into diamond funds,” he stated. “Diamond prices have dropped very sharply in recent months. Is this a good time to invest in diamonds? It depends on your investment appetite."

 

Although the idea of investing in diamonds has popped up several times over the past decade or so, it generally was not taken further due to the perceived difficulties of investing in gems. Since diamonds are so heterogeneous, unlike gold or platinum for which single prices can be quoted, it traditionally was regarded as difficult to persuade investors to put their money into the gemstone.

 

In the diamond sector itself, there was a residual reluctance to promote diamonds as an investment tool, mainly because of an ill-fated period in the early 1980s when the price of high-end one-caraters soared, only to collapse spectacularly, leaving a good number of the industry's most well-known companies floundering in its wake.

 

But the investment experiment in the 1980s was haphazard, and confined largely to the diamond industry, with diamantaires often paying massive premiums on De Beers' sight boxes, which frequently were sold unopened time and time again. Furthermore, when prices plummeted, both the industry and the banks rewrote the rule books to prevent such a debacle from reoccurring.

 

Institutional investors have been considerably more conservative when approaching the diamond industry. A diamond investment trust, established by investment firm Thomson McKinnon in the 1980s, was closed down after a drop in the market. More recently, Diamond Circle Capital Plc, the first publicly listed fund to invest in diamonds, has been standing still for the past two years since it lost more than half of its value in the 2008 crisis as investor interest in its expensive diamonds slumped.

 

However, several factors have helped change investors' positions and persuaded some that such funds can be not only viable, but highly profitable. Firstly, there is the financial volatility which has continued for the past three years since the near financial meltdown of September-October 2008. Then, there are the sharply rising diamond prices seen in the past year or more, and certainly since the start of this year.

 

In addition, there were widespread reports that the easy portability and inherent value of diamonds further boosted their prices as they were sought after by the wealthy in Middle Eastern states as a result of the so-called Arab Spring earlier this year. Concern among the wealthy political and business elites in the countries of North Africa and the Gulf that popular revolutions could see their wealth confiscated is reported to have persuaded many people to place their cash, and faith, in diamonds.

 

The renewed interest in diamonds as an investment tool was certainly reflected in a memorandum of understanding and framework agreement concluded between the Antwerp World Diamond Centre (AWDC) and ICBC, China’s biggest state-owned bank, and one of the largest financial institutions in the world. The agreement provides the possibility of additional sources of financing for the diamond trade though the provision of alternative investment opportunities for the bank's more than 240 million private and corporate clients.

 

Among the companies that have set up funds is diamond miner and jewellery retailer Harry Winston Diamond Corp. It launched a first fund in May, and is reportedly mulling a follow-up with its partner Diamond Asset Advisors (DAA), whose chairman, Peter Laib, said the concern was encouraged by the fact that the supply of diamonds was not projected to grow in the years to come since no new mines have been discovered. And even if a new mine is found, the nature of the diamond business means it would take many years for diamonds to come on stream.

 

The fund will purchase diamonds, and provide direct exposure to the wholesale market price of polished diamonds. It is expected that $100 million will be raised this year, with the outstanding $150 million due during 2012, subject to market conditions. Conscious of the issue of the difficulty in being able to provide clear indications of diamond prices, DAA said the structure of the fund offers a solution. That is because it is highly liquid, since whenever Harry Winston sells a diamond, the fund has a trade.

 

The independently managed $250 million fund will see Harry Winston source polished diamonds for the fund to purchase. In the portfolio, 75 percent are diamonds of 0.50 to 5.99 carats, and 25 percent in fancy colors or larger stones, the company said. The diamonds will be consigned to Harry Winston which will act as custodian and use the diamonds in its products. When Harry Winston sells jewellery it will pay the fund the current wholesale replacement price. Ongoing replacement of the diamonds used creates a mark-to-market for the fund by providing a yardstick to determine the market value of the diamond fund.

 

The move also makes a new source of diamond inventory available to an expanding salon network without making additional demands on working capital, as well as supporting an expanding bridal business where clients prefer to review a wide range of diamonds at each salon. In addition, it reduces inventory financing costs and improves returns on capital.

 

Harry Winston would be interested in a second fund with DAA, said its Chief Operating Officer Ray Simpson. If there is strong demand from investors for the first fund, the second could be launched immediately after the first sometime next year. Meanwhile, DAA said interest in the fund was very large.

 

Michael Shaw, managing director at Bristow Shaw & Company, which is aiming to raise $25 million-$30 million for the Australian part of the investment, said the fund will be offered in a private placement to qualified investors, and aims for a return of 12 percent annually net to investors.

 

De Beers, over the past three years, has also reported strong interest from various investment firms in diamonds, although there have not been any public announcements of a fund formation. However, Diamond Trading Company CEO Varda Shine recently said the firm was seeing more demand "from a greater variety of sources" and "new types of demand, or a different consumption rationale evolving".

 

She said that interest in diamonds and gold as tangible assets, and a means of diversifying investments, had grown among investors who had seen traditional investment vehicles break down.

 

Martin Rapaport, whose Rap diamond price list is widely used in the industry, is working on a fund. The Rapaport Diamond Fund will be a proprietary diamond investment fund that enables the financial community to invest in diamonds. The fund will offer "extraordinary levels of transparency and efficiency enabling access to investment grade diamonds fair market values" according to the company.

 

Rapaport said in August that it would start with more than $10 million, before increasing in size to more than $100 million. He told Bloomberg News that the fund would begin operating in the first half of 2012, and initially would be open only to institutional investors. Called the Rapaport Diamond Fund, it will be secured by polished diamonds that his company will buy and hold.

 

“The financial markets are weird and people are looking for alternatives to holding the dollar,” Rapaport told Bloomberg. “In that kind of environment, diamond prices are going to do very well.” Rapaport said that global demand could outstrip supply by at least 75 million carats by 2025, as producers struggle to find commercial deposits of rough, while demand continues to increase in Asia.“Diamonds are going to track exponential growth of wealth in developing markets. Chinese demand for diamonds is simply fantastic, so is Indian.”

 

Another diamond investment fund has been created by businessman Clive Cowdery with Diamond Capital Ltd, with a reported capital raising of $20 million. The founder of a firm called Resolution Ltd. who made about $240 million buying and selling insurers, said his aim was to diversify risk.

 

 However, investors are not simply showing their interest in buying into diamond investment funds. “Diamond companies look underpriced versus gold, and silver stocks on a price-to-net-present-value basis,” wrote Edward Sterck, diamond-producer equity analyst for BMO Nesbitt Burns in London, in a recent research report.

 

Gold and diamond prices have traditionally moved together, with diamonds generally attracting a higher price, however gold prices have been higher than those for diamonds since the 2008 financial crisis. That was because jewellery sales dropped in the wake of the recession, while gold was seen as a safe-haven investment. However, the theory that gold could only drive higher took a bash in September when the price of bullion plummeted quickly on profit taking. While gold supplies remain ample, the increasing scarcity of diamonds will push prices higher, Sterck believes.

 

“Rough diamond production peaked in 2006,” Sterck said. “Despite some returning production and a handful of new mines forecast to enter production … rough diamond supply is highly unlikely to ever return to its 2006 high water mark." He added that in the long term, the outlook was extremely positive.