A new way to invest in diamonds?

The luxury goods market is booming thanks to Asia's growing spending power. And that means increased demand for the most luxurious good of all: diamonds. Hence this new investment initiative.

Anyone that has ever taken a look at the luxury goods industry will understand the importance of Asia in this market. Burberry, Louis Vuitton, Gucci All these companies have a major Asian focus. Indeed, the new Asian wealthy classes appear to be even more label and fashion conscious than the Italians, and that's saying something.

Total wealth of the rich and mass affluent in 12 Asian countries should hit $610bn by 2015 from $301.2bn at the end of 2005, according to a report by MasterCard International. Indeed, Asian consumers now account for as much as half of the global luxury industry. That's some spending power.

Diamonds are not included in this estimate but they should be. The same trends seen in other luxury goods will be repeated in diamonds Diamonds, after all, are one of the most luxurious goods of them all. Asia is going to be in the driving seat when it comes to diamond pricing over the next 10 years.

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When I wrote about diamonds earlier this year I received an email asking whether I believed that investors should buy physical diamonds and stuff them under their mattress as a way to play the sector. I am not an expert in the physical stones and therefore it is not something I could suggest however, it looks like the next best thing is about to appear a futures market. The only problem is that I don't think it will work.

For years investors have been using derivative contracts in precious metals, soft commodities such as sugar to hedge against losses. It looks like we will be able to invest in diamond futures very soon following a move this month by The Rapaport Group, a diamond price and information provider.

This move is not news. In 1972, 194 diamond contracts were traded on the West Coast Commodities Exchange in the US, but the market collapsed after 2 weeks and it was never tried again.

It is easy to see why this market failed so I will be intrigued to see what happens should the new contracts be offered. The problem is that diamonds aren't really a true commodity.

Let's look at the definition of a commodity.

"A physical substance, such as food, grains, and metals, which is interchangeable with another product of the same type."

That's fair enough when we consider gold, for example. A bar of gold bought from BHP Billiton is essentially the same as a bar of gold from Anglo American. They look the same, they have the same properties and cost the same to buy.

However, this is not the case when it comes to diamonds. Every single gem is different they vary in clarity number and type of inclusions lustre and colour. These factors all affect the price of a diamond.

So, an individual parcel of 100 carats of diamonds will not achieve the same selling price as a previously-sold 100 carat parcel they are not directly comparable. This differs from the usual commodities in that an ounce of gold from one source is the same as an ounce of gold from another source.

This means using a monthly auction to set prices for a futures contract will be pretty hit and miss. Using a tender auction to set the price could also arouse suspicion. It would be easy for the unscrupulous to move the market in their favour by making false bids.

So, although I think this is very interesting news and I will watch the rebirth of diamonds futures closely, it is not a market I would participate in until it has proved itself. The market is not transparent enough for me and the variation in quality of stones means that diamonds barely meet the definition of a true commodity. All this means that the futures market will be difficult to price.

This article is taken from Garry White's free daily email Garry Writes'. For more information please click here