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Out with the Gold and in with the New?

Frank Baum advised over 100 years ago to “follow the yellow brick road.” Whether or not you believe he was promoting the gold standard, the fact remains that investors and the financial sector have taken gold seriously for a very long time.

More recent years have seen an interest shift from gold to diamonds as a commodity. This begs the question: Are diamonds a good witch, or a bad witch?

Diamonds—The Uncooperative Commodity

The defining characteristic of a commodity is its across-the-board value. Commodities are supposed to measure solely by quantity, since the quality should be standard. This presents a problem for diamonds. The price tag is virtually impossible to standardize, because the whole of a diamond is more than just the sum of its parts.

Unlike a straightforward ounce of gold, an ounce of diamond (approximately 141 carats) would vary wildly in price. After all, we could be talking about hundreds of average-sized engagement ring diamonds valued around $1 million USD or just 3 stones like the Hope Diamond that would take a billion-dollar bite out of your wallet. Size matters, and bigger is better. And there’s more to a diamond’s worth than its weight. What about the cut? The color? The clarity? Individual diamonds don’t even appreciate or depreciate at the same rate.

How does one regulate such an uncooperative asset? The answer is, they don’t. Each diamond must be spot-priced individually. Investors who don’t truly know their rocks can get burned. And your local jeweler is not interested in giving you an investment deal.

Speaking of your local jeweler, it is important to understand the difference between the investment diamond market and the secondary, consumer diamond market. Getting cash for diamonds and trading in the secondary market happens away from Wall Street through dealers such as WP Diamonds, a branch of White Pine Trading LLC.

Not All That Glitters

Regardless of weight, diamond prices have risen every month since early 2011. Compare this steady price growth to the recent volatility of the price of gold during that same time frame. Despite value spikes that doubled the price of gold between 2009 and 2011, today’s valuation has sunk low enough to match that of late 2010.

But that’s in the past. What does the future hold? Bain & Co. released a study projecting that, thanks to the rise of the middle class in China and India, diamond demand will grow twice as fast as supply over the next decade. A shortage in the market means higher prices, which are expected to reach record highs each year through 2020.

The future looks bright for the sparkly stones.

The Diamond Rush

Diamond has been notably steadier than its tangible asset cousins. This can be attributed to its low level of speculative investment (about 1%). Gold comes in at around 40%, which can explain the value fluctuation that comes with the fickle, stampede nature of investor sentiment.

As the foundation is laid for diamond to trade as a commodity, the influx of investment capital will undoubtedly impact price. We may very well see a market reaction similar to what happened when the SPDR Gold Shares ETF (GLD) came onto the scene in 2004—a doubling followed by a quadrupling. Only time will tell.

Diamonds or Gold?

What it really comes down to is what factors matter most to the individual investor.

Diamond:

• Pro - Strong market outlook
• Pro - Relatively stable
• Con - Complicated valuation

Gold:

• Pro - Consistent pricing
• Pro - Long history as a commodity
• Con - Highly volatile

This was posted in Bdaily's Members' News section by Julio Martinez .