Diamond ETFs offer investors exposure to the eponymous precious stone, but do not function exactly as most investors expect. Unlike with gold, there is no liquid market for diamonds, meaning the ETF invests not directly in gems, but in diamond industry companies.
Q. So the name here sounds pretty descriptive…. An ETF that holds diamonds, like the ETFs that hold gold… but, no so fast, huh?
A. Not so fast. There are, of course, very large gold ETFs that actually own the bullion, and there are others that own stock in gold miners. The diamond ETF is like the second type… it invests in companies in the diamond business, not in the gems themselves — even though the ticker is GEMS.
Q. And that’s a big difference, since obviously you’re getting all sorts of operational business risks in the basket, not just the inflation play of the diamonds themselves.
A. Right, that’s the big point. And this is not the only place it happens, at all. Timber, farmland, water, all sorts of ETFs that sound like you’re investing in the related hard asset actually do not. And its really a fundamental issue, since so much of the idea is the inflation protection of the asset itself – you don’t want market and operational risk. The Gold ETF is kind of a red herring for other hard asset ETFs.
Q. Well, why isn’t there an ETF that actually holds the gemstones directly?
A. Various groups are working on it, but there are several fundamental problems. The biggest single one is pricing transparency… there just is no reliable, transparent market that generates reliable pricing. Part of that, of course, is that diamonds are not fungible, like gold is: there are all the subjective elements of the five Cs involved. So if the ETF holds specific stones, how exactly do you determine their value over time?
Q. But still there is a lot of investor interest in diamonds themselves as an inflation hedge, like gold and silver…
A. Yes, and, like gold, diamonds have been a form of money– in the Middle Ages, people would sew them into the linings of their clothes… at least, their easier to transport than gold. But, as money, diamonds have some huge problems– take a gold bar, cut it in half, and you have just made it easy to divide among friends. Do the same thing with a diamond, and you’ve totally destroyed its value.
Q. Still, the point here is that even if you love the stones as an inflation hedge, right now the ETFs don’t get you there…
A. And that’s true in most hard asset categories… again, the example of the gold ETF throws people off.