Diamonds Aren't an Investor's Best Friend

A drooping dollar and inflation worries have bolstered the price of gold and other commodities that are generally considered robust investments in rocky times.

Do diamonds share the same luster?

In most cases, no. Some investors buy diamonds in the form of mining company stocks, many of which are not listed on an organized exchange or on Nasdaq; a larger diamond-mining company, Mountain Province Diamonds ( MDM) is listed -- and is up 51% so far this year. The bump appears to be based more on speculation, however, because the company's mine isn't yet producing. You can also get exposure to the diamond market through jewelry company stocks such as Tiffany & Co. ( TIF) or Zale ( ZLC).

But for most people, diamonds are bought and sold through a jeweler. Many a groom has found himself convinced to spend a big chunk of his yearly salary because of the stone's perceived "investment" benefits. But for those who think they might be able to resell individual diamonds at a profit, the chances are mighty slim. Diamonds usually are a way to spend money -- sometimes a lot of money -- not make it.

Crystallized carbon -- what we call diamonds -- is rarer than other forms of carbon, such as the carbon dioxide gas that wreaks havoc with global temperatures. Elemental carbon in all forms, however, is a common substance. It's in food, clothes and gasoline. Under intense heat and pressure, elemental carbon can form gorgeous diamond crystals, but those conditions can be duplicated in a laboratory. As technology improves, it's likely that more and more man-made diamonds will come onto the market.

Stores of Value

Diamonds are sometimes lumped together with gold and other precious metals when investors seek safety in volatile markets -- not because they trade like gold, but because they are often considered to be similar rare and valuable substances. These materials are seen as stores of value, expected to keep their worth when other investments falter.

In financial terms, a store of value is a commodity with no cash flows. Its price is expected to increase along with inflation. Common stores of value include precious metals and undeveloped land. Stores of value are generally low-risk ways to hedge one's purchasing power; as an added advantage, most of these materials can be owned in useful forms. Land can be owned as part of a housing or commercial building. Precious metals can be owned as coins, jewelry or spoons.

Precious stones also can serve as stores of value. But here's the rub: Precious stones don't trade freely. There's no afternoon price fix and no quote to look up. Much of the value of a precious stone is determined by appraisers from competing trade organizations, who can be subjective in their analysis. One person's opinion, no matter how learned, is no match for the power of the market to determine prices. This means that diamond sellers can get different appraisals, and different offers, for stones that in theory are fungible. Many jewelers avoid dealing with secondhand diamonds for fear of casting a pall on the market mystique, but plenty of jilted brides have found a great secondary market on eBay.

De Beers Corp. more or less operated a near monopoly in the diamond market from 1934 to 2000, and it still controls roughly 40% of the market. When it dominated the market, the company could set prices and sold only as many diamonds as current market prices could bear -- lots of diamonds if demand was high enough to keep prices high, and only a few if the price support wasn't in place that year. De Beers marketed diamonds as a symbol of love. It discouraged jewelers from dealing in secondhand diamonds by agreeing to buy back stones for its own inventory, further controlling supply.

Price and Quantity Problem

South Africa is the traditional home of diamonds, but Russia, Canada, Australia, and India all have viable mines. Many yield low-quality stones, but improvements in laser technology make it easier to improve their color and clarity. Diamond companies take raw stones, cut them into shapes that enhance their natural beauty, and then use lasers to lighten and even eliminate cloudy spots and flaws. As lasers improve, a greater number of natural diamonds meet jewelry-industry standards. That's why shopping malls flaunt $99 diamond pendants at holiday time.

De Beers lost its monopoly when it could no longer control the supply. As mining and laser technologies improved, De Beers watched independent miners and manufacturers put stones on the market. By 2000, it said it would stop managing the diamond market and start marketing diamonds under the De Beers name.

To stand above the cheap diamonds sold to high-school lovebirds, diamond companies trademarked their cut patterns and used lasers to etch serial numbers or brand names on the stone. Prospective grooms now have to decide what shows love the most: a diamond ring in a blue box from Tiffany; an inscribed Millennium diamond with a loupe included; or a microscopic polar bear to prove that the diamond came from conflict-free Canada, unlike diamonds from parts of Africa where sales revenue may have been used to pay for civil conflicts.

Stores of value generally maintain their price. Investment goods like stocks and bonds are expected to increase in value, and consumption goods like cars, clothing, and furniture in most cases go down in price.

Now, if you're still convinced that diamonds are a good investment, your best bet is to buy exposure to them through stock in a jeweler. Or, go to the jeweler and buy a diamond for someone you love and not as an investment.