Invest Like a Billionaire: Diamond Bling

photo: Swamibu

This Sunday, the Red Carpet at the 83rd Annual Academy Awards (alright, the Oscars) will drip with diamonds from the likes of Fred Leighton and Neil Lane. Someone may even top the 7,645-diamond, nearly 1,400-carat L’Wren Scott necklace Nicole Kidman wore to the star-studded event three years ago. Diamonds are truly a girl’s best friend.

Diamonds can also be a good bet for investors, especially in a market fraught with geopolitical turmoil. Diamonds are considered by many to be a store of value similar to gold; as global demand for diamonds increases, prices will pick up. The IDEX Diamond Price Index has increased 10% over the past year, against reported shortages. According the latest IDEX market report, some diamond dealers are saying they are seeing the highest demands in a decade due to the lack of goods.

Though there is no diamond fund or ETF yet, word on the street is that diamond giant De Beers, owned by billionaire Nicky Oppenheimer and family, is considering offering ownership of its diamonds without physically taking receipt, similar to other physically-backed commodity ETFs. In the meantime, there are several opportunities to take part in the diamond dash.

At the Counter

To be clear, a diamond purchased at the store (be it Tiffany’s or your local independent jeweler) is far from an investment. Diamonds are meant to grace your fingers, wrists or neck, but don’t expect to recoup their value by reselling one you bought at the retail level. (They’ve been marked up one too many times by the time they reach the end customer.)

That said, there is opportunity for those looking to invest in diamond retailers themselves.

De Beers, which has been in the Oppenheimer family for over 80 years and controls about half of the world’s rough diamond supply, is looking for growth at the retail level where customer demand has been spiking, especially in emerging markets like India and China.

“Broad-based diamond and luxury sales [are] strong domestically and abroad as consumers, particularly if they are well-employed, breathed a sigh of relief and increased spending, often on small luxuries,” says Morningstar analyst Paul Swinand. He adds that this pent-up demand, along with an uptick in engagements, makes both high-end and low-end retailers attractive investment opportunities. (Note: Research from the University of Virginia’s National Marriage Project suggests that marriages decline in the mid-single digits during recessions, but rebound when the uncertainty resides.)

Well-known brand retailer Tiffany’s (TIF), is one of the publicly-traded diamond retailers (De Beers is private) benefiting from the boom. The company’s trademark little blue box enables it to charge a premium for his offerings; it also promotes its unique jewelry collections by famous designers, such as the Frank Gehry line. Also new and doing well: its collection of exclusive yellow diamonds. The stock is up 43% over the past year.

Swinand adds that on the other side of the price spectrum, Blue Nile (NILE), the online diamond retailer, is also benefiting from the engagement surge. The company is able to provide lower prices because of its diamond-sourcing model: it sells suppliers’ inventory without having to buy it first like traditional retailers. Blue Nile then passes on some of those savings to consumers.

Mining Diamonds

Jewelry is only one of the end applications for diamonds. Diamonds are also increasingly being used in industry. They have the hardness and conductivity to polish and cut any material; they are used in saws, abrasives, construction, computer chip production, lasers and surgical equipment – basically every industry that touches your life. Indeed, the majority of diamonds mined today are used for industrial purposes.

RBS Capital Markets analyst Des Kilalea says that the diamond mining world is small: four large producers account for about 90% of the world’s rough diamond production: privately-owned De Beers, Russian state diamond monopoly Alrosa, Rio Tinto (RIO) and BHP Billiton (BHP). Though the diamond mining industry is about one fifth the value of the gold mining industry, Kilalea says it is attractive because it is widely profitable, with over 80% net margins. In addition, existing mines are getting old and new supply takes time to ramp up, so shortages may drive rough diamond prices up.

Rio Tinto has interests in three diamond mines; it also has a relatively stable cash flow and lower operating risk than many of its mining peers, according to Morningstar, which expects the company to grow. Over the past year the stock price increased 35%. The other advantage: because Rio Tinto mines iron ore as well as other metals, the company is less susceptible to market imbalances than single-commodity producers.

The same is true for BHP Billiton, the world’s largest publicly traded mining conglomerate. With its proximity to China, the company is well positioned for future expansion, according to Morningstar. The company’s stock price has risen 25% over the past year. Even India’s mining billionaire Anil Agarwal has stated he plans to spend $9.6 billion to replicate the strategy of BHP Billiton for his own portfolio.

The End Game

To be sure, unless you have a sizable portfolio and feel comfortable investing in individual stocks, you may simply consider investing in a proxy such as sector specific iShares S&P Global Materials (MXI), which focuses on large global materials firms; 58% of the fund is comprised of metals and mining companies including Rio Tinto and BHP Billiton. However, because this exchange-traded fund��is a concentrated bet on a very narrow segment of the market, investors should treat it as a tactical investment, suitable only “as a complementary satellite holding in a diversified portfolio,” writes Morningstar’s Robert Goldsborough in a recent report.

As always, diversification should remain a key part of your investment strategy. According to Morningstar, a 4%-10% total weighting for all direct commodities exposure is sufficient, any diamond exposure would be a subset of this. Many individual investors may be better off dedicating a smaller share to that – or any other — industry. Be sure to consult with your financial planner or adviser (if you have one) before making any radical portfolio moves.

Tatiana Serafin, a former staff writer at Forbes, now heads Global Markets and Ideas.