Are Diamonds an ETF’s Best Friend?

From the list of assets that haven’t yet been turned into exchange-traded funds, you can strike another one: diamonds.
Today, GemShares, a Chicago-based financial firm, is expected to secure a U.S. patent for its process of turning diamonds into tradable securities.
Diamonds and other precious stones are a sizable part of many people’s fortunes; a recent survey by Barclays Wealth found that 70% of rich investors around the world own precious jewelry, up from 57% five years ago. On average, they have 5% of their assets there – equal to their stake in gold.
But diamonds are idiosyncratic. They vary on the famous “four Cs” of carat, color, clarity and cut. Each dealer may put a different price on the same stone. The gap between what a dealer will pay to buy a stone and what he or she will charge to sell it can be wide, and an important diamond can take years to sell.
In short, one of the hardest substances known to man is also one of the least liquid. “Everyone knows the price of gold,” says Andrew Feldman, a financial adviser who helped develop GemShares. “No one can tell you what the price of diamonds is: Each one is unique unto itself.”
GemShares came up with what may turn out to be a clever solution: creating an index, or benchmark “basket,” in which diamonds are arranged in 10 layers of comparable quality and value from cheapest at the bottom to most expensive at the top.
By precisely defining the attributes of each basket and layer, GemShares hopes to ensure that it can create as many tradable units as the market will bear – making diamonds “fungible” for the first time. To provide transparency and avoid some of the controversy that has dogged gold ETFs – “How do you know the ingots are in that sealed vault?” -GemShares may even post online images of each diamond in the basket, says Feldman.
Initial demand for diamond securities is likely to come from diamond producers and dealers – much the way farmers or gold-mining companies have long used agricultural commodity futures or gold ETFs to hedge the risks of a fall in the market prices for their production.
Eventually, speculative or investment demand may follow. If, as many people believe, gold is a hedge against a decline in the value of fiat currency, or paper money, then diamonds could serve the same purpose – especially since they are more portable. Just think of all the diamonds that refugees have sewn into the linings of their coats before fleeing societies in collapse.
Along with serious uses, more frivolous ones come to mind: Rich celebrities about to pop the question could always buy diamond futures or a diamond ETF. That way, if Katie or Ivana breaks things off and keeps the enormous rock, at least the rich cad still has a holding that might appreciate.
Since the patent has just been granted, says Feldman, GemShares doesn’t yet know when it may have tradable securities ready; he says the firm is already in discussions with major financial companies, however. Look for the possibility of diamond futures or ETFs sometime after mid-2013.