Diamonds To Outperform Gold In 2012?

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The 2012 diamond outlook is positive as is this year’s forecast for gold. But, do the gems have the potential to outperform the metal? It’s a question that some ask, but one whose answer contains so many variables that it is almost too complex to answer with any certainty on a broad basis.

Diamonds and gold are very different types of assets. People have a wider range of means and motives for playing gold. In addition to that, as Bain and Company‘sDiamond Industry report highlights, a major problem with investing in this asset class is the difficulty in obtaining an accurate industry wide price picture.

An ounce of gold is an ounce of gold and there is a spot market to communicate the current price for it. The yellow metal is expected to make a 19 percent gain in 2012, according to Bloomberg’s analyst estimates.

Diamonds, however, are not created equal and their prospects will vary depending on where an investor’s focus lies. To oversimplify the options, diamonds can be divided into rough stones, investment diamonds (mainly whites between 1 and 5 carats) and special/rare diamonds. For the two latter categories there is little available in the form of reliable pricing forecasts. Estimates for rough diamonds price increases are highly variable ranging from 5 percent to over 10 percent.

The Bain report states that rough diamonds have been showing a steady growth trend of about 3 percent per year.

Saul Singer of Fusion Alternatives said that over the past decade, diamond prices have been highly correlated to gold prices. But, he sais over the past 18 months gold has been heavily influenced by global macro-economic uncertainty and inflationary risks.

Although these factors influence diamond prices, they do so to a lesser extent. Demand and supply have been the main drivers for diamond price movements, he added.

Asian demand as driver

Diamond demand is expected to increase by about 6 percent per year through 2014, providing strong support for prices. Asian demand, especially that from India and China, is largely expected to be an increasingly positive and important component of that growth in the upcoming years, including 2012. This upward trend is already in motion.

However, economic conditions cannot be discounted completely. Bain’s report says the global diamond jewelry market moves parallel with markets for luxury goods and other jewelry.

Most of the diamond demand from Asia is predicted to be for jewelry. Positive economic conditions in the region should, therefore prove bullish for diamonds prices. But investors should stay abreast of reports that those economies are cooling off as this could present a downside risk for luxury goods, including diamonds.

Also, it is premature to turn a blind eye on demand from developed nations. To date, the US still maintains its title as the top diamond consumer.

Gerhard Prinsloo, of Bain, said they are not predicting the demand for diamonds in India and China to match that of the US and Europe until 2020.

Edward Sterck of BMO Capital Markets said if we see Europe act as a drag with perhaps some contagion through to the US, that could knock 1.5-2 percent off the growth forecast. Though, he added this would likely be a short term effect from which the market would quickly recover.

Supply Risk: A driver in 2012

Growing diamond demand, especially given the increasing appetite from Asia, is expected to outstrip supply in the future. In 2012, however, diamond production is expected to increase.

But, demand for investment grade diamonds is already outstripping supply, according to Singer. This has been the case for the past 5 years. These conditions are expected to continue in the medium term he added as there has not been any world class diamond mine discovery in the last decade to shift the supply curve– a factor that adds to optimism surrounding diamonds’ performance.

Diamond investing in 2012

The 2012 outlook for diamonds is positive when this class of assets is viewed singularly, and it is reasonable to expect positive performance from the diamond market, though selection continues to play a major role is success.

Singer says that best diamond play is to invest proportionately in investment and special/rare diamonds.

However, this is both a high risk and capital intensive move. When comparing diamonds to gold for the purpose of investment decisions certain historical realities remain: diamond investing remains specialized regardless of the potential regards and gold continues to be more appropriate for a broader range of investors.