Diamonds are a guy's best friend

By David Stevenson

My better half never used to like jewellery - thank goodness - but, after talking to one of her friends, she's started leaving leaflets about diamonds lying around the house. Even the children have mentioned it recently - according to my daughter: ADVERTISEMENT

"Mummy says she'd love a nice diamond". Well, Daddy would love a nice twin-engine plane, but he's not getting that either.

This response has so far failed to silence the 'debate'. Apparently, my wife's friend has declared that, "diamonds are a much better safe haven than all that brash gold". She's obviously been listening to the marketing bods from De Beers who are preparing an advertising campaign based around just such a thought: why bother buying gold as insurance against monetary fiat, when you could have a lovely white diamond?

This also seems to have been the thinking of the super-slick diamond thieves who took down a Mayfair jewellers a few weeks ago for £40m plus.

In honesty, I do see their point. Gold is so, well . . . boring and samey. What I mean is that gold never looks unique. In a generic sense, it all looks the same. Diamonds, on the other hand, have always struck me as distinctive and individual - no two high grade diamonds are ever quite the same and I'm guessing that the market for investment grade diamonds is inefficient and riddled with 'emotion'.

Like all emotional assets - a term I've discussed before with reference to collectables - value is set by what a buyer will pay. So, if that buyer is a Russian oligarch or Middle Eastern potentate, then the sky's the limit. That imperfection in the marketplace is both a risk and a potential source of reward.

The risk is that 'insiders' will take you for a ride. It's a particularly big risk in the diamond sector where many auctions are closed. But the potential rewards are that, with the right 'alpha' - or expert investment manager - you can exploit these markets to add some non-correlated returns to your portfolio.

Until recently, there wasn't a way of testing this theory. Then, last summer, some adventurous types launched a listed diamond fund called Diamond Circle Capital. It buys high-grade polished diamonds, including coloured and large white stones, with an average purchase price of £3m-£5m. The fund is 90 per cent invested and is managed by the commodity specialist Diapason Commodities Management.

With hindsight, the summer of 2008 was not the ideal time to launch a fund that invests in a luxury product influenced by high-spending Americans (50 per cent of the market), Russians and Gulf princes. De Beers, for instance, cut back Q1 2009 output 91 per cent year on year, and profits tumbled. So the fund is down 50 per cent in price terms since launch, with net assets down 28 per cent.

But my contrarian instincts suggest that this woeful situation might be worth a second look based on the following:

● 5ct diamond prices have outperformed gold bullion over the last 25 years - they may even be a better hedge against inflation.

● Global supply of crucial Kimberlite deposits is in decline.

● Chinese demand is ramping up. A recent article on the IDEX news website noted: "Chinese diamond imports were up nearly seven per cent in the first half of 2009 . . . between January and June, China's foreign diamond trade amounted to $692m, a growth of 6.9 per cent compared with the same period last year. The total included a record $300m in imports, up 12.7 per cent . . . China has become the world's third largest diamond consumerafter the US and Japan."

● US demand for diamonds might also increase when the US economy picks up.

● Shares in Diamond Circle Capital are trading at a 30 per cent discount to net asset value (NAV) in a sector where pricing is fairly liquid and open.

Take these together, and you can begin to see why diamonds might make a very small 'alternative assets' holding.

But, before you get too carried away, consider one piece of recent research. Last year, I wrote about the work of Bernard Duffy and a team of academics who had studied "emotional assets" including diamonds and other collectables. They found that, over the 30 years between 1976 and 2006, diamonds (as measured by the HRD Carat D Flawless Index) had produced a return of 4.4 per cent (above coins, clocks and watches) but with a massive standard deviation of 19.5 per cent. Over the 20 years to 2006, that return had dropped to just over 2.5 per cent but still with a big 10 per cent standard deviation.

They also noted: "Some collectable items show a tendency to move in line with each other, with a high correlation coefficient, such as diamonds and coins, books and atlases, and clocks and watches and stamps."

However, diamond enthusiasts argue that this recent under-performance has ended and supply/ demand forces will reassert themselves. If they're right, Diamond Circle Capital could be an interesting, sideways bet on growing affluence in the emerging

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