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Diamonds and Correlation

Diamonds and Correlation

Consider the following graph of three diamond indexes: RAPI 1 Carat by Rapaport, IDEX Diamond Index, and Mercury Diamond’s Mercury Diamond Global Tracker™ (MDGT™). The three track diamond prices and generally move in the same directions. The variations are due to differences in methodology and what is being tracked. They differ mainly on a micro level. On a macro level, the general trends are virtually identical: prices rose until mid-2011, dropped sharply and then moderated through mid-2012, before falling again and then climbing a little until late 2015. From that point, we saw an ongoing, yet mild downward slope that continues today.

b2ap3_thumbnail_Leading-Diamond-Indexes-May-2009---November-2017_20171218-084356_1.png

It is not surprising that the three behave this way, because they all track one commodity – diamonds.

We tend to view commodity price changes as being influenced by several forces: supply, demand, speculation and general market trends. The first three forces are easily understood, the fourth really means that when the economy tanks or shoots up – as it is doing today – is has a significant impact on commodity prices and is also manifested by them. This is generally true for all indexes, be it of stock markets, bonds, cost of housing and more, which is why they are commonly referred to as economic indicators. So when a stock exchange drops, shares traded on other exchanges tend to decline too, and bonds suffer and when it hits consumers’ pockets, housing prices decline as well. But is this always true? Is this true for all commodities? Are they all impacted to a similar degree?

The simple answer is no. Indexes do not move in unison and, even if they reflect similar economic trends, they may change at different ratios. Gold, for example, is where investors tend to go when the stock market falls. As the following graph shows, when the subprime recession hit in October 2008, housing and the stock markets declined, while gold prices quickly started to increase. When the economy improved, the price of gold declined, as investors pulled their money out of gold and invested again in other places, such as the stock market.

b2ap3_thumbnail_Gold-Stocks-US-home-prices-January-2008---November-2017.png

When we compare diamond prices to prices of precious metals, we see a somewhat different trend. Gold, silver, platinum and diamonds tend to generally rise and fall at the same time. The big difference is the rate at which this happens. However what is most interesting is that the fluctuations in precious metal prices are far flung, while diamond prices are relatively very stable, as the following graph shows.

The price stability of polished diamonds are, on one hand, very surprising, as they are, after all, a purchase of choice, not a necessity. They are not rice or clothing. If times are economically hard, and consumers tighten their belts, you would expect prices to free fall. This is not the case.

b2ap3_thumbnail_Polished-Diamond-Prices-vs-precious-metals.png

When thinking of investment strategies, a basic rule is to not put all your eggs in one basket. Why risk your money on one stock that may decline and diminish your savings, when you can buy a basket of shares and spread the risk. The logic holds for the macro economy – why hold onto shares only when the entire stock market can crash, as it has time and again in the past. Logically, expecting it to happen again makes sense, and therefore seeking a hedge is only natural. The tendency of some economic tools to rise or remain stable during periods of economic downturns is of course an important economic trend, because it allows investors to add cautionary elements into their investment portfolio.

This brings us back to diamonds. Compared to the stock market, other equities and overall commodities, the behavior of diamond prices is stable and lacks the wild fluctuations seen among most other investment venues. As the following graph shows, the one investment venue that is as stable as diamonds is bonds. Bonds are a conservative investment option added to investment portfolios to decrease risk.

 b2ap3_thumbnail_Polished-Diamond-Prices-vs-economic-indicators.png

How closely different economic tools correlate are of importance to investors who want to diversify their portfolios and protect themselves against a sharp and widespread decline. That is one of main attractions of bonds. Bonds, however, are not without risk, especially at a time of economic calamity. The bond issuer may suffer from the down market and be unable to pay some of their debt, or even default. The same is true if a company’s credit rating is lowered. And while investors could mitigate the risk by investing in many different bonds from different sectors, they still want to look outside of the regular options and find a few additional venues to invest in. And this is why some investors look at diamonds as a possible option for wealth preservation.

If we look at many different investment venues together – the stock market, bonds, precious metals, and other commodities – and compare them to gold, we see that diamonds are relatively stable, lack wild fluctuations, and are not subject to credit ratings or a company’s ability to pay its debts. It is in fact a solid commodity.

b2ap3_thumbnail_Polished-Diamond-Price-Correlation.png

Diamonds have their own shortcomings. First and foremost are price disclosures and where to trade them. These two are essential elements for any investment tool. That said, we are not far off. The Mercury Diamond suite of diamond price tools provides price discovery to anyone who wants to know what the price of any diamond is, regardless of its characteristics. The more detailed the search, the more accurate the results. Which leaves us with the need for a trading platform, which at this point does not exist.

If we put our minds to it, develop educational tools, provide clear knowhow, and accurate details about diamonds, we will take important steps towards a trading market open for investors. The importance of such a forum cannot be stressed enough. Not only will it provide us with an additional outlet for diamonds, it will play an important role in keeping the diamond market afloat during a time of economic downturns. That would be a refreshing change for the diamond industry.

The views expressed here are solely those of the author in his private capacity. No one should act upon any opinion or information in this website without consulting a professional qualified adviser.

 

Diamond Portraits - Robert Shipley Sr.
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