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With equities and commodities in turmoil, diamonds offer a measure of stability - 31.08.15

The laws of gravity, which so long appeared to have been suspended when it came to the Chinese economy, reasserted themselves once again, during a month when much of the world was out on vacation.


The episode effectively began on August 11, when the Chinese government ordered its central bank to devalue the renminbi by 1.9 percent against the U.S. dollar, the largest single adjustment in two decades. At the same time it moderately liberalized its monetary policy, announcing that, from then on, the midpoint of the Chinese currency’s trading band would be based on the previous day’s closing price, rather than being controlled centrally.


As a result, further cuts in the value of renminbi followed on August 12 and 13, meaning that, in the space of just three days, the Chinese currency weakened by 3.8 percent to its lowest level since mid-2011.


Then, on August 24, the Shanghai Composite Index fell 7.6 percent in early morning trading, to below the 3,000 mark for the first time since late 2014, and down 42 percent from its peak just three months earlier.


While the jury remained out whether the slide represented a correction or a crash, confidence in the ability of the Chinese authorities to manage the crisis appeared to have been severely dented.


The Chinese prime minister, Li Keqiang, and the vice premier, Ma Kai, were reportedly the architects of a plan rolled out in July to rescue the stock markets, which now most commentators agree was a spectacular failure. It included about $200 billion worth of stock purchases by state-owned institutions, which within days saw a major part of their investments devastated by the fall in stock market prices. Unsurprisingly, the government now appears to have now abandoned the ill-advised strategy of propping up the market with state funds.



Commodities fail to provide relief for investors


The direct impact of the crash was limited internationally, since foreigners own just 2 percent of the shares on the Shanghai stock exchange. But China’s status as the world’s second largest economy and the second largest importer of both goods and commercial services, meant that few would be unaffected, and, as a consequence, the world’s equity markets went through a rollercoaster ride during the days that followed.


Typically, an upheaval in the stock exchanges would have had investors fleeing to the commodity markets, but the fact that it involved China, a country which has been propping up almost all commodity prices for years through its massive consumption, resulted in a exactly the opposite reaction.


After rallying for two days, and actually rising by about 10 percent in value, international benchmark Brent crude oil fell below $49 a barrel, pressured by a looming supply glut and concern about a hard landing for China's economy. It previously had been heading for its fourth straight monthly decline and has risen in value during only two of the past 14 months. Also down sharply were industrial metal prices, including those of iron, copper, nickel aluminum, zinc and lead.


Even gold, most traditional of “safe haven” investments did not do as well as one would have expected. It actually fell during the sell-off on August 24, although not to the same degree as stocks, but recovered slightly and then remained relatively steady. 


Silver, another precious metal that is considered by some to be a reasonable safe-haven investment, although it does have industrial applications, was especially hard hit, falling to a six-year low of $13.87 per ounce on August 26.



Current market conditions leave investors with few safe havens


One of the outcomes of August 24 fall in the Shanghai Composite Index was a reinforcement of a growingly pervasive sense felt by many investors that there is no place to hide. In a market environment characterized by low interest rates and volatile equity and commodity markets, the range of safe haven options are extremely limited.


This is not necessarily the case across the board since there are options that are available to high net-worth individuals that are not always accessible to others. Property developers in countries like Australia, Britain and Canada, for example, were reportedly bracing for a surge of new interest in their already over-heated markets, amid reports that wealthy Chinese were seeking safe havens.


But the high-end property market is not a panacea for most investors. Indeed, under currently conditions, say certain analysts, the term safe haven investment itself is an oxymoron. Wealth preservation, they suggest, should be the ordinary investor’s primary goal.


In the meantime, a great deal of capital has leaked out of the equity markets, and is currently parked in liquid assets like U.S. Treasury bonds and safe-haven currencies such as the Swiss franc, but is looking for investment opportunities. According to Bank of America Merrill Lynch, Chinese investors sold shares worth 360 billion yuan ($58 billion) during the the first five months of 2015, compared with 190 billion yuan in all of 2014 and an average of 100 billion yuan in prior years.


“It isn't enough to put your money into so-called conservative investments,” wrote Julian Close this month on the NASADQ website. “The mere fact that an investment – say, a bond – provides only a low return is no guarantee that it won't also lose market value when and if the market crashes. You need to move some of your money into investments that will preserve your wealth no matter what happens.”



Diamonds an effective means of reducing investment volatility


“There are no magic solutions or 100-percent safe havens in the current investment climate, but that should not be a taken to mean that wealth preservation is an impossible task,” said Etan Müller, CEO of DFI Switzerland. “The common-sense approach of building a balanced portfolio, spread across a variety of asset classes, remains the most sensible one. However, given the volatility of a great number of the standard investment alternatives, it is strongly suggested that one also looks outside the box.”


Established in 2012, DFI Switzerland engages independently and actively in the investment diamond field and specializes in alternative tradable investment portfolio types. These are each comprised of physical high-quality diamonds that have been acquired specifically for a client, according to his or her liquidity requirements. This differs from most of the other players in the investment diamond space, who typically manage funds backed by diamonds.


“We obviously would not suggest that any individual invest his entire retirement fund in diamonds,” Müller stated, “but what we do contend is that investment grade diamonds provide an increased degree of stability and flexibility in a diversified portfolio. There are a characteristics associated with diamond investments which are particularly convincing in a challenging economic climate, such as the one we are experiencing at present.”


A DFI study, which looked at the correlation between diamonds, gold, commodity indices, government bonds, and currency and equity prices from 1999 through 2015, showed that diamonds rarely move in relation with other asset classes. Small, zero and even negative correlations to other asset types, the company discovered, makes the precious gemstone a particularly effective means of diversifying an investment portfolio and also is an efficient tail-risk hedge, by significantly reducing volatility.

Correlation table

SOURCE: DFI Switzerland 


In contrast, a just published Bloomberg article noted that the correlation between gold and the Chicago Board Options Exchange Volatility Index, or VIX, which measures turbulence in the equities market, is at its "highest level since October 2013.”


Speaking to Bloomberg, Charlie Bilello, the director of research at Pension Partners LLC, who studied the performance of gold against other assets using data going back to 1976, said that the strengthening relationship between gold and the VIX shows that the odds of the precious metal acting as a haven in times of such turmoil is “about as good a coin flip.”



Diamonds are a safer bet during times of crisis


“We conducted a study that looked at price performance of high quality diamonds, of 1 carat, 2 carats, 3 carats and 5 carats, during crisis periods, including the sub-prime crisis in the United States starting in the third quarter of 2007 and the Eurozone debt crisis starting during the fourth quarter of 2010. What we discovered is that when the equity markets fell, diamond prices rose,” Müller said.


“As the traditional safe haven, gold prices also rose during those periods, sometimes quite significantly. But the gold prices index was significantly more volatile than the prices indices for high-quality diamonds in the various sizes. They were far more like to establish a new plateau, while gold may fall as dramatically as it rose,” Müller continued.Crisis correlation

 SOURCE: DFI Switzerland


Polished diamond prices have not been able to escape entirely the precious commodity slump of recent years, but compared to gold, price movement has been decidedly non-volatile. Thus, while gold peaked at $1921.50 per ounce on September 6, 2011, it was trading 42 percent lower at $1,117 during the latest Chinese equity market crisis. The IDEX Online Polished Diamond Price Index peaked at 146.7 in July 2011, up from 120 just six months earlier. In July 2015, it stood at 132.2, about 10 percent lower. More significantly, it had remained in the 130 to 140 range since November 2011.


While diamond prices in general are non-volatile, certain sized diamonds are more volatile than others, with stones 3 carats and larger generally more likely to demonstrate price movement than smaller-sized stones. While that may alarm some investors, especially during the more trying periods, it does have its upside. According to DFI research, between 2004 and 2012, while prices of 1-carat diamonds rose by almost 70 percent in value, prices of 3-carat diamonds rose by about 145 percent and prices of 5-carat diamonds rose by almost 165 percent.


“We are fully cognizant of this phenomenon, and consequently assist our clients create portfolios that include diamonds of different sizes,” explained Müller. “This a provides them with a considerably degree of flexibility moving forward, since they are always able to cherry pick what diamonds they wish to sell, and what goods they prefer to hold over the longer term. Unlike gold, silver and platinum, this is a not ‘a one size fits all’ phenomenon.”


Most important, despite the uncertainty over the state of the Chinese economy, the fundamentals of the natural diamond market are unchanged. Through to the mid 2020s at least, long-term demand for polished diamonds will outpace the growth in rough diamond supply. Upward price movement would appear inevitable.