Kris Schellhas of the Investment Diamond Exchange talks about the hardest—and most up-and-coming—asset: diamonds.
[This interivew originally appeared on HardAssetsInvestor.com and is republished here with permission.]
Precious commodity investments have long been investors' safe haven when markets turn against them. But with gold prices in flux and massive outflows from gold exchange-traded products, it might be time for the gold standard of commodity investing to make way for a new poster child.
According to Kris Schellhas, managing partner at the Los Angeles-based Investment Diamond Exchange, diamonds are that poster child. IndexUniverse Staff Writer Hannah Tool recently spoke with Schellhas to talk market monopolies, the threat of synthetics and the highly anticipated, physically backed diamond ETF from Chicago-based finance firm GemShares.
IndexUniverse: What is the Investment Diamond Exchange?
Schellhas: Investment Diamond Exchange (IDX) is an internationally recognized diamond exchange located in Los Angeles. We offer individual investors a liquid and price-transparent market for one- through five-carat diamonds, round brilliant, GIA [Gemological Institute of America]-certified investment-grade diamonds.
IndexUniverse: Talk a little about the GemShares Physical Diamond Trust.
Schellhas: On Aug. 7, 2012, the U.S. government patented a process that classifies investment-grade diamonds for commercial trading and financial investments, the precursor for diamonds being a publicly traded asset class. As a result, GemShares has registered with the SEC to release a physically backed diamond ETF. The ETF is anticipated to be available on the Nasdaq by 2014.
IndexUniverse: Since it's physically backed, will shares be redeemable for physical diamonds as well?
Schellhas: The registration documents indicate that shares will indeed be redeemable for baskets of investment-grade diamonds; however, all of the details on redemption have yet to be released.
IndexUniverse: It's been nearly a decade since De Beers privatized and its monopoly on the diamond industry was vanquished. Why has it taken so long for a diamond ETF to arise out of that shift?
Schellhas: The introduction of a physically backed diamond ETF has been in the works for a number of years, but one wasn't going to be launched unless all of the challenges involved with creating a physically backed diamond ETF were overcome. You have to build a model that'll work with the idiosyncratic nature of different variations of diamonds, and that takes time.
IndexUniverse: What kind of challenges had to be overcome before this ETF could go into registration?
Schellhas: First of all, liberalization of the diamond industry had to occur before a diamond ETF could become a reality. De Beers was privatized in 2001, effectively ending a century-long monopoly. By the end of 2004, the De Beers stockpile was depleted, allowing diamond prices to trade on supply and demand fundamentals just like any other commodity.
De Beers' current market share is less than 35 percent, sharing production with Rio Tinto, Alrosa, Dominion Diamond Corp. [formerly known as Harry Winston], Petra Diamonds and several smaller players.
IndexUniverse: What about liquidity? Would a diamond ETF face liquidity issues?
Schellhas: It will be as liquid as any other publicly traded instrument. With the diamond ETF, investors are buying a share of a trust backed by physical diamonds.
IndexUniverse: How do diamonds compare to gold, as an investment?
Schellhas: Historically, diamonds have proven themselves to be significantly more stable than other tangible assets, such as gold and silver, largely because diamonds have almost no exposure to speculative capital [roughly 1 percent]. Gold, on the other hand, has a speculative investment share of approximately 40 percent, and as result, is highly volatile.
Diamonds are more of a noncorrelated asset and they're a great hedge against inflation. Additionally, they're a play on global growth—as global growth increases, so will consumers' purchases of luxury items.
IndexUniverse: What makes the diamond market move?
Schellhas: Diamonds are a supply-and-demand-driven industry, just like any other commodity. Diamond prices are currently being supported by the rising incomes of middle-class populations in emerging markets like China, India, Russia and Brazil. Developed economies like the U.S. and Europe are relatively flat with regards to the growth in diamond demand—in the U.S., diamond demand is growing at approximately 3 percent a year.
Meanwhile, in countries like China and India, demand is expanding at an incredible rate and really driving unprecedented demand for diamonds. These countries not only view diamonds as jewelry, but a lot of the people purchase them as a source of wealth too.
In China alone, diamond demand has a compound annual growth rate of 32 percent since 2005.
Even more interesting is the fact that industry experts across the board agree that the supply of diamonds will at best remain unchanged throughout the decade, because all major diamond mines are at peak production. In fact, even if a large diamond mine were to be discovered, it takes roughly eight to 13 years of development before a mine can begin to produce diamonds, since diamonds are mined in some of the most remote and inhospitable areas on earth.
IndexUniverse: Are synthetic diamonds a threat to physically backed diamond investments?
Schellhas: For consumers to embrace synthetic diamonds on a large scale, the price of high-quality synthetics would have to dropconsiderably. Regardless, the vast majority of consumers are only interested in natural diamonds, so it is highly unlikely that synthetic diamonds will have any kind of measurable impact on the price of natural diamonds over the next decade.
IndexUniverse: When people are investing in physical, natural diamonds, where are they investing, geographically?
Schellhas: Africa, Canada, Australia and Russia are the primary mining sources for diamonds in their rough form.
Once they're taken out of the ground, they're sold to cutting and polishing factories around the world. Those cutting capitals are Israel, Antwerpand India. China is also emerging as a cutting and polishing center simply because the labor there is cheap.
IndexUniverse: How do you see physical diamonds fitting into the broader scale of commodity investments?
Schellhas: The current state of the global economy is highly conducive for owning diamonds. Diamonds provide investors with a stable and highly transportable storage of wealth, while offering an attractive profit potential based on the tremendous growth potential of emerging economies. With the prospect of significant investment capital flowing into this asset class in the near future, it becomes clear why diamonds are positioned to be the best-performing tangible asset of the decade.