Increased demand has pushed up prices by 80%

A diamond is the hardest natural material known to exist.

It also might become one of the hardest materials to find in the future. So says DeBeers, the world’s biggest diamond producer, at least.

The company has a particularly gloomy outlook on the sparkly gems. Saying that world sources are depleting too quickly to meet long-term demand. Unfortunately, many others in the industry agree with the assessment.

That means ladies may have to settle for smaller “bling” under the Christmas tree. And gents should expect to shell out a bit more cash when buying gifts for their female friends.

But as for investors… well, they can do quite well if they know how to play it right.

Diamonds are becoming even more rare

During the cold war era, the United States and the old DeBeers cartel hoarded large amounts of diamonds. But those stockpiles have long since disappeared.

New supplies doubled between 1980 and 1999 around the world. Huge new mines such as Argyle in Australia and Diavik in Canada came on-stream. And the 21st century can claim Zimbabwe’s impressive Marange field.

But otherwise, not much has happened in the last 10 years. And Zimbabwe’s political turmoil has industry insiders worried anyway.

Knowing all that, DeBeers sees diamond supply tracing an “elephant curve” over the next two decades. That means that production will resemble an elephant’s back, tailing off gradually.

Over the next few years, it expects global production to come in at the 110-130 million carat range and its own between 30 and 40 million.

Ice, ice baby

With diamond mines already depleted, demand from emerging markets might make the shortage even worse.

The Financial Times reported on a Chinese woman who recently walked into a Harry Winston boutique in China. She then proceeded to ring up $30 million worth of diamond jewelry.

DeBeers CEO Gareth Penny doesn’t think she’ll be the last one to do so:

“If you look back 20 years, there was no diamond acquisition culture in China. But today in Beijing, Shanghai and Guangzhou, there is an obvious launch pad: 40% of brides in those cities are getting diamond engagement rings. It was zero 15 years ago.”

Of course, the U.S. still consumes the most diamonds in the world. But China and India keep increasing their appetite for the shiny things. Hence the reason why DeBeers has decided to limit its production permanently to no more than 40 million carats.

Though it doesn’t have the same control it once did, DeBeers is still the most powerful player. Its sales arm accounts for about 40% of rough diamond sales. So this strategy should allow it to continue influencing prices.

It also suits the changing times…

In 2008, demand for rough diamonds was about $13.4 billion globally. And 2009 saw it fall to $7.5 billion as inventories were run down. This forced DeBeers to slash its production to a mere 24 million carats, earning it a $743 million loss in the process.

But demand is expected to hit $12 billion this year. So DeBeers has raised its Botswana mine production to 31 million carats.

It should profit nicely off of that, considering a recent analysis by an RBC Capital Markets analyst, Des Kilalea, says that increased demand has pushed up prices by 80%.

An investment gem

Unfortunately for investors, DeBeers is no longer publicly traded. Anglo American ADR owns 45% of it. The Oppenheimer family claims another 40% and the Botswana government holds the rest.

Meanwhile, Rio Tinto ADR (NYSE: RTP, Stock Forum) owns the largest stake in the Argyle and Diavik diamond mines. But the mining giant isn’t worth buying for its diamonds alone.

Harry Winston Diamond Corporation (NYSE: HWD, Stock Forum), however, is. Formerly the Aber Diamond Corporation, it sells fine jewelry and watches in 19 locations, nine of which are in Asia. And it owns a 40% interest in the Diavik diamond mine. As of 2009, it had produced 56.3 million carats.

Since it is a rough diamond producer, a polished diamond buyer and a retailer of fine diamond jewelry, the company enjoys unique profits.

It also puts it in a perfect place to take advantage of increased prices for rough diamonds. Mr. Kilalea says that for the next few years, rough diamond prices should rise in real terms by at least 5%. It could even “easily be 10% or 12%.”

And since the afore-mentioned Chinese shopper more than likely won’t be the last to spend such an extreme amount of money on her diamonds, Harry Winston should be able to take advantage of increased retail sales as well.

Disclosure: The author does not own positions in any of the stocks mentioned