Diamond ETF: a gem of a trading opportunity
You could argue that an asset’s right of passage to the commodity world is becoming an exchange traded fund (ETF). If true, diamonds might be the next asset to become financially tradable.
Several developments in the past year point to this and open up the prospect of multiple trading and investment strategies on diamonds, actually turning them into a genuine financial asset. For instance, one of such recent developments is the UK’s Financial Conduct Authority’s (an authorised Benchmark Administrator under the European Benchmark Regulation, EBR) approval of the four investable polished diamond indices: USD Composite Diamond Index, USD Diamond Price 1.0 Carat Index, USD Diamond Price 0.5 Carat Index, USD Diamond Price 0.3 Carat Index.
This is the first time a diamond-based index has been fully-regulated under strict FCA rules. Moreover, this approval allows financial institutions and issuers to reference products to 0.3, 0.5, 1.0 carat and composite indices. These indices are a source of independent pricing information and start to address price transparency among multiple grades of diamonds in the market.
Due to the market’s size and the benefits diamonds can offer as a financial asset class, many attempts have already been made to create products that allow their trading within financial markets. Nevertheless, all of these attempts were unsuccessful, largely because they failed to solve the key issues of a lack of fungibility, a lack of transparency and a lack of liquidity – probably the biggest barriers stopping the diamonds from entering the financial markets:
- Fungibility – unlike gold, platinum or silver, diamonds are not standardised and each diamond bears unique characteristics.
- Transparency – the diamond industry lacks clear and transparent pricing, this makes it difficult to understand how diamonds are valued and priced.
- Liquidity – diamonds are mainly sold to end consumers in a one-sided transaction, so one cannot resell his diamond in a fair market value.
Previous attempts to create a diamond ETF involved different diamonds being grouped together in a basket and presented as a single price asset that might have reached hundreds of thousands in USD. Such diamond baskets just cannot be fungible as the derivative products cannot be disconnected from the underlying asset.
Therefore, before a financial product enters the market, it has to be broken down and evaluated. The product is then derived from the price of the underlying asset.
Genuine financial assets need to have strong foundations to be feasible, including live and transparent pricing and the ability to trade the underline in a financial exchange. This is exactly why Cedex devised, built and proved the DEX algorithm. It solves the issues of fungibility, transparency and later, down the road, the liquidity in the market, making a diamond ETF and futures a viable financial tool and an integral part of the new financial ecosystem.
The proprietary algorithm is based on an artificial intelligence (AI) methodology that creates a scalable gemological benchmark and calculates a diamond’s Estimated Market Price (EMP). It solves the problem of transparency by using multiple data points to give users easily accessible and understandable investment information. Through pricing confidence, the DEX has removed the most significant obstacles of fungibility and transparency and enabled the evaluation of the underlying assets.
This combination of the DEX, gemological benchmarking and a live parallel pricing data from over 1,000 wholesalers make the creation of a diamond ETF achievable. The last hurdle, liquidity, will be solved by bringing together all the players in the new financial ecosystem. We intend to join forces with different counterparties to complete this global ecosystem.
A mainstream diamond market has massive potential. Diamond sales is currently around $90 billion annually, with the financial trading estimated to be just $1 billion. Once diamond ETFs are viable, there is definite scope to see the latter figure grow exponentially and surpass the former. Likewise, a new ecosystem built around the financial diamond market will inevitably create a plethora of financial options for both diamond buyers and sellers.
On the sell side, there will be a great opportunity for existing diamond professionals to open a new distribution channel to investors. In addition, and for the first time, retail owners of diamonds will be able to liquidate their diamonds in a transparent way without having to use pawn shops or low paying venues.
On the buy side, diamonds hold many benefits and have the potential to be a leading financial asset. An obvious benefit is a lower cost-of-carry due to diamonds being low in volume, but high in value, boasting a difference of 30 to 40 base points against gold. Furthermore, diamonds’ various shapes, sizes and prices may actually be beneficial. The fact that they are so diverse means they are able to provide traders with a selection of investment strategies, something that other precious metals don’t offer. Traders have the option to use low volatility diamond categories to hedge for preserving capital or take a more speculative position in some of the more volatile diamonds categories.
The dynamics of the financial markets may be hard to predict, however, we expect to find diamonds in growing importance as a tradable asset class in the years ahead.
By Saar Levi, CEO and co-founder, Cedex