Proof That Diamonds Aren’t An Investor’s Best Friend

March 13th, 2012 by Louis Basenese

Submitted by Wall St. Daily as part of our contributors program

By now you’ve probably seen a solicitation for diamonds as an investment. They’re typically pitched as an alternative to owning precious metals like silver and gold. And even hedge fund managers are getting in on the craze.

At the 2011 Ira Sohn Investment Conference, Jeffrey Gundlach, of DoubleLine Capital, trashed gold for being too heavy to carry. His preference? Gemstones. As he said, “You can carry $25 million of rubies in your shoe with your foot still in it.”

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He has a point. But does ease of transport make diamonds a sound investment?

IndexIQ, a New York-based provider of exchange-traded funds, certainly hopes so. Last week, the company filed an S-1 form with the SEC to market a diamond ETF. It’ll be the first of its kind in the United States.

No date or exchange has been selected for the official launch. We also don’t know what the fund’s expense ratio is going to be.

Nevertheless, we can already write off this product – with the help of a single chart – as an all-around bad investment. And here’s why…

It’s a No-Go on the Fundamentals…

In its 2011 Diamond Industry Report, Bain & Company reveals the two key sources of demand in the diamond industry: jewelry and industrial applications. It goes on to state, “An additional potential source exists in the investment community, but to date, demand for diamonds as an investment vehicle has been small.”

Ironically enough, IndexIQ draws attention to the weak investment demand for diamonds in its very own filing, too, saying, “A limited investment sector exists [for diamonds] consisting of private individuals and investment funds seeking to invest directly in physical diamonds.”

How limited? Very limited. Case in point: IndexIQ was only able to identify two diamond funds in existence – a closed-end fund traded on the London Stock Exchange and a private fund run by KPR Capital.

Add it all up and the lack of any meaningful investment demand means one thing: The market price for gem-quality diamonds, which the fund plans to invest in, is driven almost exclusively by demand for diamond jewelry. And that’s a problem.

As IndexIQ reveals, “Diamond retail demand is [only] expected to grow by approximately 3% annually to reach $90 billion in 2015.”

I’m sorry. Ninety billion might represent a big market in dollar terms. But 3% annual growth is hardly enough to lead to a meaningful increase in price. And if we’re investing in diamonds, all we care about is an increase in price, right? If that’s the case, the investment prospect for diamonds is unattractive.

But what if we treat diamonds, instead, as a store of value during times of economic uncertainty, like silver and gold? Here, too, the investment case is dim, at best.

While IndexIQ notes “there has been a significant increase in diamond prices” since 2003, the increase pales in comparison to the rise in gold and silver prices. Take a look:

Based on the PolishedPrices.com Diamond Composite Index, diamonds are up 46.5%. Not bad, until you realize gold and silver are up 384.7% and 593.5%, respectively, over the same period.

Bottom line: IndexIQ is going to find out the hard way that diamonds may be a girl’s best friend, but not an investor’s. The lack of liquidity, poor demand and, most importantly, weak long-term performance make diamonds a terrible alternative to investing in gold and or silver.