RAPAPORT... The diamond industry is undergoing a period of great challenge and opportunity as a rapidly expanding global economy creates unprecedented wealth. Demand for large, fine-quality diamonds has increased significantly over the past few years, while supply has remained stable due to natural scarcity. Although demand for smaller, less-expensive diamonds has declined due to adverse U.S. economic conditions, prices for large, expensive diamonds have surged in a speculative spiral fueled by dealer expectations of ever-increasing prices. Higher prices and scarcity have also encouraged conspicuous consumption, whereby wealthy consumers want more diamonds as their prices rise. The demand curve for the best diamonds has inverted, with higher prices increasing demand instead of decreasing it.
Surging global demand and a rapidly declining U.S. dollar have pushed commodity prices to record highs, while destroying confidence in the dollar as the primary international store of value. Over the past year, the major Indian, Israeli and Belgian trading centers have seen a 10 percent to 15 percent decline in the dollar. Diamantaires, having lost confidence in the dollar and expecting increasing prices for large diamonds due to a consistent imbalance between supply and demand, now prefer to keep their wealth in diamonds instead of dollars. This monetizing of diamonds is a rational development that is having a major impact on diamond prices.
While higher price levels that reflect a long-term imbalance between supply and demand are sustainable, higher prices brought about solely by internal diamond industry speculation are not sustainable. Members of the diamond trade must consider the price level at which they are buying. If the price level reflects reasonable, sustainable broad-based external consumer, or investment, demand, prices can be expected to hold over the long term in spite of short-term volatility. On the other hand, if a significant component of the price level is based solely upon internal diamond industry speculation that short-term prices will continue to rise, then even a slight short-term price decline can cause a collapse. Simply put, if the only buyers are other dealers, you are in trouble.
All prices are unpredictable and, therefore, all market positions carry risk. Diamantaires who buy diamonds in order to sell them to specific customers through established marketing channels have limited risk. Those who buy diamonds to hold them in hopes of higher prices are subject to greater risk. Volatile market conditions dominate the global economy and, at some stage, it is reasonable to expect a temporary decline in demand and prices. Trade speculators, particularly short-term smaller players who are not financed to handle a downturn, can be expected to dump and run.
The current market situation evidences a high level of trade speculation in large diamonds. It is therefore prudent for us to warn the trade to carefully consider price sustainability before investing in diamonds. When the trade pushes prices to levels well above what consumers or “external” investors are willing to pay, or when the only incentive for buying is an addiction to yet-higher prices, the stage is being set for trouble.
We must recognize that speculating, investing and holding diamond inventory are legitimate, natural, rational and healthy market activities. Speculation is not evil; it is legitimate investment. Without dealers holding goods, there would be no market and buyers could never find the diamond they need. A key question is how to deal with the inevitable price volatility and monetization of diamonds. It is high time for the diamond industry to legitimize speculative investment through the establishment of free, fair, competitive and transparent spot cash and derivative markets.
The risk of price collapse and loss of legitimacy is greatest when there are no checks and balances against internal diamond industry speculation. Professional commodity arbitragers will integrate diamond prices with volatile currency, commodity and equity markets. These “outsiders” will reduce risk as they sell against irrationally exuberant diamantaires and buy when we do not recognize the true value of our diamonds relative to other market prices.
The greatest threat to diamonds is not speculation and inevitable price volatility, but honest pricing. Diamond prices must be balanced to be legitimate. The question is not whether diamonds are a commodity. The question is whether diamonds prices are legitimate.
Article from the Rapaport Magazine - March 2008. To subscribe click here.