Investing in diamonds: Interview with CEO of world's first diamond ETF

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By: Alisha Hiyate
2013-11-08

Last November, New Jersey-based PureFunds launched the world’s first diamond and gemstone ETF, the PureFunds ISE Diamond/GemstoneETF (NYSE: GEMS). The company, which at the same time also created an ETF tracking silver juniors and one tracking mining equipment and service companies, has 24 stocks in its diamond ETF, including juniors, diamond miners, and even Sarin Technologies, which makes diamond grading and cutting machinery and tools. PureFunds CEO Paul Zimnisky recently spoke to Mining Markets about how the fund came about and why investing options in diamonds remain limited.

Mining Markets: Why did you launch the diamond and gemstone ETF?

Paul Zimnisky: The idea was to come out with industry specific funds that were not yet being tracked by an ETF. I’ve always watched the diamond space quite closely and it was one of those things where I’d want to get exposure to it, but was limited to only a few pure-play companies that I could buy in America or Canada, you just had a few choices and a lot of them were small-cap, illiquid names. So I wanted to create a fund that included the largest, most liquid pureplay companies in the industry from all over the world. That was the idea, and then to securitize it in one fund – you can now buy one symbol (NYSE: GEMS) and get broad global exposure to the industry.

MM: How did you select the companies to include in the ETF?

PZ: The ETF currently holds 24 stocks traded on exchanges in six countries with business operations expanding the globe. There are only a handful pure-play gemstone companies that are big enough and liquid enough to be included in a public fund like ours, so we pretty much included everything that fit. The weights of the constituents vary based on factors like size, liquidity, and most importantly how “pure-play” they are, or in this case how tied the companies' business models are to the sensitivity of diamond/gemstone demand. The goal was to exclusively include pure-play names, but we ended up including, for example, Anglo American (LSE: AAL) because they own 85% of De Beers, which we thought was imperative to hold. We tried to stay away from the large conglomerates [like Rio Tinto] whose earnings are primarily driven by other commodities.

In addition to miners, the fund includes diamond retailers, and diversified diamond companies like Chow Tai Fook, which is a vertically integrated diamond company that’s the biggest diamond play in greater China (which includes mainland China, Hong Kong, Macau and Taiwan). A few years back, they IPO’d 20% of the company which valued it at $20-billion. It’s come in since then, but its still an enormous company and most investors in North America don’t have access to it. That’s one of the nice features of our fund, you get exposure to a company like that. The fund also holds Petra Diamonds (LSE: PDL) and Gem Diamonds (LSE: GEMD), which are listed in London, and not readily available to investors in the U.S. or Canada.

MM: You’ve got a couple of exploration stocks in there as well, like Peregrine Diamonds (TSX: PGD).

PZ: Yes, given the lack of new diamond supply coming onstream in the foreseeable future, we thought it was very important to also include explorers and developers, which will be the future of industry supply. Other juniors the fund holds include Stornoway Diamond (TSX: SWY), Shore Gold (TSX: SGF), and Mountain Province Diamond (TSX: MPV; NYSE-MKT: MDM)

Mountain Province’s 49%-owned Gahcho Kué project in the Northwest Territories is the largest diamond project in development at the moment. The joint venture with De Beers is expected to produce 5 million carats a year for at least 15 years starting in 2015, which would make it a top 10 producing mine globally.

MM: Will Russia’s Alrosa (MICEX: ALRS) the world’s largest diamond producer by volume, be added to the ETF index now that some of its shares (16%) are trading publicly?

PZ: I cannot comment on that at this time, as additions and subtractions to the index will be publicly disclosed during the semi-annual rebalance period which will next take place on the third Friday in December.

However, regarding the Alrosa IPO, I think it's worth noting that Russia's President Vladimir Putin has insisted that public offerings of Russian state companies be done on the Moscow Exchange, ruling out more liquid, deeper markets in Hong Kong, London, and New York, which I think will really limit access to Western investors. I think they are ultimately doing a disservice to themselves with that decision.

MM: Have you found that there’s been more interest or less interest than you thought there would be in the diamond ETF?

PZ: A backdrop of subdued investor interest for mining stocks in general lately has been disappointing, and this has carried over to funds like our diamond industry ETF. There’s no question that the mining industry is out of favour right now, that said, our fund is actually up (4.5%) year-to-date, which I think is very impressive for a mining-heavy fund in this market. Relative performance ultimately speaks for itself and I think that is what will drive investor interest at the end of the day.

MM: How tied is performance of the fund to diamond prices?

PZ: It is difficult to quantify this since diamond prices tend to vary depending on the pricing source and the type of diamond that is being used as the pricing proxy ie. size, quality, etc. What I can say is that the goal of the fund was to create a product that holds companies poised to benefit the most if demand for diamonds and gemstones accelerates.

But just to give you an idea, I believe that Citigroup did some research on this a few years back, and if I recall correctly they found that Harry Winston Diamond's (now Dominion Diamond [TSX: DDC; NYSE: DDC]) stock price had a correlation of around 0.68 to physical diamond prices.

MM: Diamond prices in general have become very volatile since De Beers gave up control of the industry. Is that a concern for you?

PZ: No. The diamond market is, now more than ever before, being driven by market forces -- which makes the industry investible in my opinion. This is a good thing. Between 2001 and 2004, when De Beers decided to step away from a monopolistic model and liquidate their diamond inventory stockpile (the tool they used to control prices), demand actually increased for diamonds over that period, but the diamond prices decreased. This served as evidence that De Beers was in fact following through with the liquidation of their stockpile. Looking at diamond prices from 2004 to today, there has been unprecedented price volatility because diamond pricing is being driven by market supply/demand dynamics, not De Beers. Investors want the price of whatever they are ultimately investing in to reflect the market. I think this is the first step towards gaining more investor interest in the diamond industry.

MM: Often when people think about investing in diamonds, they do think about buying physical stones. So what’s the advantage of investing in the ETF over a fund that invests in physical stones?

PZ: Whenever you invest in a company (or a basket of companies like our fund), you are betting on the company producing a certain level of cash flow, or the company increasing the value of an asset, as well as betting on price appreciation of the commodity that the company is geared towards. If you are investing in a fund that strictly holds a physical commodity, you are solely betting on the price direction of that commodity. So it all comes down to investor preference. Some investors prefer to hold both as they feel the two investments complement each other.

Physical diamond investment is a more complicated process compared to gold or silver since diamonds lack fungiblity -- meaning they all have different characteristics. Therefore, at the moment, there is no one particular mainstream physical diamond investment fund as there is with gold. Currently, diamond investment only represents a tiny fraction, probably around 1%, of total diamond demand, compared with about 40% for gold. Most of the investment demand for diamonds comes from high-net worth individuals, primarily in Asia, buying high-quality stones and putting them away in safe boxes.

I think more investors would like the option of buying diamonds to diversify their hard asset, gold-heavy portfolios, and I think situations like the one in India, where the government is artificially making gold less appealing by raising import duties in an effort to reduce the current account deficit, will naturally draw more attention to diamonds as an investment. The global investment community is beginning to take notice of this -- which can be seen through the emergence of new attempts to securitize physical diamonds for investors.