Diamonds or Stocks? The Choice is Clear

Ken Gassman

It seems like the past half decade has been bumpy for the diamond industry. Diamond prices have been on a roller coaster, diamond industry credit has tightened and uncertainty throughout the diamond pipeline has been well above normal. However, if you’d held S&P 500 stocks, you’d really have something to moan about. Not only have stock prices been volatile, but also the return on investment has been negligible. While diamantaires have complained about price volatility of polished diamonds, it has been modest, when compared to the price volatility of stocks in the U.S. market. At their lowest point, stock values plummeted 37 percent in 2008 compared to 2007.

Polished diamond prices actually held up pretty well in 2008, up 9 percent, responding only a year later, but it wasn’t really so bad: prices fell by just under 11 percent in 2009 at their worst.

Diamonds above Water; Stocks under Water
During the last market cycle, the S&P 500 Index peaked at 1530 in May 2007, before plummeting to 735 in February 2009. Today, the S&P has recovered to about 1290. The IDEX Online Polished Diamond Price Index peaked at 129 in August 2008, before dropping to 108 in September 2009. Today, the IDEX Online Index is around 138.

Thus, investors who bought stocks at the peak of the last market cycle are still under water today. In contrast, the value of the diamonds diamantaires bought at the peak in the past cycle have is above their purchase price.

Diamonds: Solid Return
Here how an investment in diamonds versus stocks would have fared between 2005 and 2011.

  • For every $1 invested in polished diamonds in January 2005, diamantaires had $1.34 at the end of 2011.
  • For every $1 invested in the S&P 500 stocks in January 2005, investors had $1.06 at the end of 2011.
  • This equates to a compounded annual growth rate (CAGR) of 5 percent for diamonds, but only a modest 1 percent CAGR for stocks.

Not only has the return on investment in the stock market been nearly nil, but the heartburn caused by unusually high price volatility has tested investors’ risk tolerance. Clearly, investors in stocks have not been compensated adequately for the risk endured.

Why Diamonds Fared Well
The diamond trading markets are closed to the public. Only a few people trade diamonds in bourses around the world.

In contrast, stocks can be traded by virtually anyone. It is estimated that there are millions of “day traders” who flip in and out of stocks, in addition to the thousands of “investment professionals” in the business.

When the global financial markets crumbled in 2007 and 2008, short sellers and computerized trading programs exacerbated the havoc. Worse, investors had “no place to hide” in the financial markets. There was no sector of stocks, bonds, commodities, or any publicly traded financial instruments that was immune to the financial meltdown. Many analysts described the heavy selling on Wall Street as “irrational”.

In contrast, the diamond trading markets were relatively insulated from the debacle of the financial markets because the public cannot trade in and out of diamonds on a whim. While the diamond markets experienced some forced selling by diamantaires facing tightened credit lines, liquidity did not dry up, as it did briefly in the public markets.

The Lesson: Don’t Open the Diamond Market to Outsiders

The diamond industry’s drumbeat to “go public” continues to get louder. We’d urge caution before opening the diamond trading markets to public traders.

Our analysis suggests that the investment returns and price volatility of diamonds in the public markets would likely correlate relatively closely with stock markets, diamonds’ return on investment would likely fall and price volatility would likely rise.

The prospect of a public trading market for diamonds doesn’t help us sleep soundly at night.