Institutionalizing Diamonds as an Asset

Recent years have seen several efforts to establish diamond spot markets. These are welcome initiatives that have the potential to transform the way diamonds are bought, traded and sold. When they succeed, they will be a key element in changing the perception of diamond purchases from an expense, into an asset, because they will establish diamonds' resale value.

One of the obstacles to establishing the diamond as an asset in the eyes of the public is the decades during which diamonds have been sold according to a completely different premise – as a component in jewelry. Diamonds were sold not for their economic value but for their symbolic emotional value.

This perception is reinforced not only by marketing efforts but also in the way that diamonds of all colors, clarities and types are sold: set in high-end luxury brand jewelry, private sales, auctions, etc. These were proven and efficient sales methods for many years; that is, until the rise of the millennial generation.

Diamonds as a commodity

Should all diamonds be sold according to these tried and tested ways? For some, this is probably the best approach. Smaller diamonds, certainly lower quality diamonds and diamonds of poor make are suited to such a method. But what about the rest? Some diamonds, we know, are more valuable. They have special characteristics that make them different enough to warrant a different approach. 

A large and high quality diamond should be sold in a different environment, within a framework that supports its unique qualities or rareness and resale value, which are additional features to its beauty. A diamond spot market, which would function similarly to a stock market, the Amsterdan flower exchange, or the grain market in Chicago, will transform these diamonds into a commodity.

A diamond spot market will allow anyone, anywhere in the world to buy or sell a diamond at any given time, as well as track its price and see the change in price of any diamond traded on such a platform – just like gold, oil, a company’s shares, flowers and wheat.

Currently, when a consumer buys a diamond, the price they pay is based on benchmark asking prices based on the 4Cs – carat, color, clarity and cut – without taking into account the hundreds of irregularities that may lead to price reductions. Traders, on the other hand, know to take irregularities into consideration when buying diamonds. This leads to large potential disparity between buying and selling price.

A spot market, like that described above, will deal with this disparity by including traders as buyers and sellers, ensuring the tracked price includes all of a diamond’s price components – including irregularities.

In order to address this issue, I developed aproprietary table of over 400 irregularities with their associated discounts or premiums. Using real transaction prices and filtering them through the proprietary irregularities table will provide a transactional price for each and every unique diamond. This renders the price crystal clear and perfectly understandable to anyone purchasing a diamond. Such a system will be no different from that which prices gold or any other commodity.

A spot market will contain current trading prices in great detail as well as historic data. Combined, this data will equip every buyer with information on every 4Cs/irregularities combination, and the price behavior of any diamond over time.

Converting diamonds

One of the issues that needs to be addressed towards forming such a spot market is that of fungibility. In the absence of a spot market, natural diamonds are currently not fungible. The current selling system based on asking prices makes finding two interchangeable diamonds challenging. This, according to the naysayers, stands in the way of turning high-end diamonds into a commodity.

A characteristic of commodities is their ability to be split in two or more and retain proportionate value. If, for example, one took an ounce of 24-karat gold and divided it into two pieces of half an once each, than the value of each half will equal half the value of the whole ounce. The same is true for five notes of $10 – they will always equal the value of a $50 bill, just as a liter of oil can be divided into three and together retain the same value of a liter. You can split the volume and still retain the value.

This is not true of diamonds. If you cut a 1-carat diamond into two equal half-carat diamonds, the individual value of each half falls by more than 50% and the collective value is reduced. After all, a diamond’s value rises exponentially with size.

However, this is a manageable issue. We at Mercury Diamond™ developed a special tool, the Mercury Exchange Converter™, which can match the current transaction price of any diamond regardless of size, color, clarity, cut, shape or irregularities to any other number of diamonds of equal value.

Which half-carat round, D color, IF clarity diamonds have the same value as a 1-carat, H color VS1 clarity diamond? The table below lists a number of such alternatives. As you go through the list, ask yourself about fungibility. If you can exchange one larger diamond with a few smaller diamonds that together have the same value, does it not bring us closer to fungibility?

The options are nearly limitless, and the tool we developed (see more details here) translates the value of any diamond one could buy, for any size, shape and clarity, to an equal value diamond or diamonds.

Using the Mercury Exchange Converter™, if you check the value of a diamond with a known weight, shape, color and clarity, you will find that it has the equivalent value of another or several other diamonds. The converter integrates my Transaction Price List – real market transaction prices backed by deep market research, which considers diamonds far beyond the traditional 4Cs and vague asking prices.

New tools for determining value

Diamonds are traded in US dollars. There is a great advantage to working with a single currency, but there are a number of drawbacks. As long as the US market was the premier diamond consumer market, a dollar to dollar comparison was straightforward. The growing importance of China and India as diamond consuming markets has brought the issue of exchange rates into play. We know that the strong US dollar made diamonds relatively more expensive in recent years, especially in markets that suffered from a devaluation against the dollar.

Not only did exchange rates go haywire, but fluctuations were widespread as well. This hurt international trade in many industries as well as diamonds. As we try to underscore the value of exchange of natural diamonds, we should ask ourselves how to address the questions many savvy buyers may ask: How can one know the absolute value of a diamond in any currency, not only dollars? How might that buyer, three years later, know the exact value of a diamond in one currency, even though it may have been bought in another? After all, with fluctuations in local currency exchange, how would one ensure that they are not selling short?

To address this issue, I recommend using the International Monetary Fund’s Special Drawing Rights (SDR). The IMF describes SDR as “an international reserve asset, created by the IMF in 1969 to supplement the existing official reserves of member countries. The SDR is neither a currency, nor a claim on the IMF. Rather, it is a potential claim on the freely usable currencies of IMF members.”

The value of the SDR is determined daily and expressed in terms of the US dollar. It is based on a basket of four major currencies: the US dollar, euro, Japanese yen, and British pound sterling. The basket will be expanded to include the Chinese renminbi (RMB) as of October 1, 2016.

The SDR is calculated as the sum of specific amounts of each basket currency valued in US dollars, on the basis of exchange rates quoted at noon each day in the London market.

Say a diamond is bought today in Indian rupees or Japanese yen for the equivalent of $100,000, based on transaction prices, its 4Cs and irregularities. In three years, when the owner is ready to sell the diamond, can the diamond be sold for $110,000? All that is needed is to see how the dollar value of diamonds with the same characteristics changed during that time, and then compare it to the local currency and its value against the SDR.

The beauty of the system is that it expands the possibilities. Perhaps in dollars the value hasn’t changed much, but in the local currency a large profit might be made. Or vice versa, maybe the exchange rate of the local currency spiked, but if the diamond is sold in dollars, an extra $10,000 can be generated.

Comparing the value of a diamond to the SDR on the purchase and sales dates is an excellent comparison basis. Consider the following graph, showing the change in value of gold, inflation of the US dollar, the SDR and a 1.01-carat, D/FL,XXX, with no fluorescence, since May 2009.

In the example above, all values are indexed to May 2009. SDR stood at the time at $1.52 and the wholesale value of 1.01-carat, D/IF, triple X, no fluorescence diamonds with no irregularities was $15,708. In April 2016, the SDR was $1.41 and the same diamonds were traded for $15,392, that is, the SDR declined by 7.5% and the value of the diamond by just 2%.

All this, coupled with the change in a diamond’s value compared to the financial markets over time (see graph below), will slowly change the perception of diamonds. It will open more possibilities to natural diamonds’ resale value after they are mined, traded and described in a fully transparent and ethical way. It will propel diamonds beyond their role as objects set in jewelry. 

If we overcome the deep fragmentation of the market, join forces and focus on creating a single, clear spot market effort, we will redefine the perception of diamonds. In this way we will stride towards a clear declaration that natural diamonds are indeed a commodity that will attract more capital and a higher turnover to the diamond value chain as well as the jewelry market. From there, the sky is the limit.

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.