The next great commodities boom story

published 2 June 2011

Last week I made my way to the Savoy Hotel for a conference. The place was packed with delegates bristling with excitement. They're on to something big, and they can smell the money.

Readers of my Red Hot Penny Shares newsletter are already in the know. I've been banging the drum about this sector for a while now. It's an industry where conditions have never looked better and I've found not one but two great ways to play it. I'm convinced that these bets are going to start paying off in the months ahead.

One presenter at this conference said that the industry could be "on the threshold of a purple patch". And without exception, everyone agreed that both the immediate future and the long-term outlook are very rosy.

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I'm talking about the diamond industry. If you don't already know why I'm excited about it (and industry insiders are too), you need to catch up.

When limited supply meets rising demand

To make a long story short, the reason for the widespread optimism for diamonds was succinctly put by Patrick Meier of RBC Capital Markets: "While production growth is expected to be slow or flat, diamond jewellery demand from emerging economies such as China and India is showing strong signs of growth."

It's very simple: limited supply meets rising demand. That means that prices can only go one way upwards. And it's already happening. Even the optimists in the industry have been taken aback by the recovery of diamond prices since the financial crisis. Here's why.

When Lehman Brothers collapsed, banks went down like a line of dominos. Diamond jewellery sales slumped and bankers refused to finance the industry's capital-hungry supply chain. The industry was in disarray, and prices crashed.

But now diamond prices have made up lost ground and much more. They're back at 2008 prices and rising. That's why I've been keen to get you into my two diamond penny shares.

But today I want to talk about another idea.

This excitement about diamonds is just one thread of a wider, more powerful, investment theme. It's the boom in luxury goods driven by rising levels of wealth in emerging markets.

How to cash in on the luxury goods boom

Makers of luxury goods are reporting an explosion in sales. Whether it's leather handbags, silk scarves or bling, nouveau riche Asian consumers just cannot get enough. Look at the numbers

Burberry (LSE: BRBY) reported 30% revenue growth from its Chinese stores in the second half of last year. First quarter sales into Asia-Pacific from jewellery retailer Tiffany (NYSE: TIF) were up 31% "due to substantial growth in most countries and especially in the greater China region".

Chinese tailors are already selling copies of Kate Middleton's wedding dress, and some Chinese couples are even copying the royal ceremony complete with gilded coaches and red-coated guards sporting bearskin hats.

The point is that the Chinese have the money and they have a taste for Western ideals of luxury. This is a perfect combination for American and European suppliers of luxury goods.

With the important US market bouncing back strongly as well, global spending on luxury goods hit an all-time high of £150bn last year. According to RBS analyst Des Kilalea, the US is still the most important single market, accounting for around 28% of global luxury goods spending. But China will soon surpass Japan to become the second largest market - and India is not far behind.

So how can you make money from this trend as a UK penny share enthusiast? That's what I'm looking at today.

We need to dig a little deeper. The question is: what specifically will these new rich consumers buy? Gold and diamonds are obvious choices.

The World Gold Council has reported a 34% increase in spending on gold jewellery in the first quarter of the year. Albeit that much of this is down to gold's higher price, this still includes 7% growth 'by weight'. Only in Japan, hit by the earthquake, and Egypt, hit by a political quake, were sales down. But sales to India were up 40% and to China a staggering 51%.

With gold also being held in preference to paper currencies, the World Gold Council sees "continued strong demand" - and the same could be said for diamonds.

"While there could be a measure of diamond price consolidation over the summer," says RBC analyst Kilalea, "we expect the trend in prices will reassert itself in the medium term we do not see any major threat to the upward trend of diamond prices."

Gold and diamonds remain recognised symbols of wealth and the Red Hot Penny Shares portfolio has both covered. But how else can investors play this powerful theme? Fancy clothing is in hot demand, as we've seen from Burberry. And in January I described how the Chinese have been bidding up the price of fine wine.

Why it's only a matter of time before these gems become more popular

But the industry that really interests me right now is the wider gemstones market. While diamonds are an established luxury backed by one of the most effective marketing campaigns ever devised, there is a long list of other precious stones that have much lesser recognition.

Rubies, emeralds and sapphires have their fans, but not the widespread recognition of the diamond. It is not just because these heavy stones are associated with aged aunts and a bygone era. It is rather due to uncoordinated marketing and unreliable supply.

I think this is changing. I think it's only a matter of time before these gems become more popular. And that's your opportunity.

Because now, some small miners are taking the bull by the horns and tackling this issue. One small miner that is doing just this is being rewarded with a rising share price. In fact its price has doubled since I recommended it to readers of Red Hot Penny Shares late last year and I think it still has plenty of potential upside from here.

I believe that luxury goods is a great place to invest but if you can pick out a company with a winning strategy so much the better. That's what this gem play and my two diamond stocks have. If you own shares in them, treasure them. They could multiply your investment in the months and years ahead although they are very high risk and there is no guarantee that this trend will continue.

If you're not already getting Red Hot Penny Shares, the question is: why not? For my specific, in-depth penny share recommendations, you should try it out. You can get a no obligation trial at a 50% discount try it for three months, and if you don't think it could help you make big money from penny shares, just let me know. You can cancel and it won't have cost you a penny.

You'll find out the names of my two top diamond plays and the gemstone stock I mention above.

Find out here how you could profit with Red Hot Penny Shares

Red Hot Penny Shares is a regulated product issued by MoneyWeek Ltd. Past performance and forecasts are not a reliable indicator of future results. Your capital is at risk when you invest in shares, never risk more than you can afford to lose. Penny shares can be volatile, relatively illiquid and hard to trade. There can be a large bid/offer spread so if you need to sell soon after you've bought, you might get less back than you paid. This can make them riskier than other investments. Please seek advice if necessary. 0207 633 3780.

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Tom worked as a fund manager in the City of London and in Hong Kong for over 20 years. As a director with Schroder Investment Management International he was responsible for £2 billion of foreign clients' money, and launched what became Argentina's largest mutual fund. Now working from his home in Oxfordshire, Tom Bulford helps private investors with his premium tipping newsletter, Red Hot Biotech Alert.