Diamonds vs. Precious Metals: What Shines Brightest in Your Investment Portfolio?

Rand Kwong Yew Low

University of Queensland Business School

Yiran Yao

University of Queensland

Robert W. Faff

University of Queensland

October 20, 2015

Abstract:

Several studies explore the use of gold and other precious metals for protecting investors’ wealth during periods of market turmoil. However, alternative investments, although increasing in popularity, still remain unfamiliar to the majority of investors. We explore the safe haven and hedging properties of diamonds versus precious metals in an international study to evaluate diamonds as a viable investment alternative. Furthermore, we compare the performance between the returns of physical diamonds and diamond indices. Our analysis indicates superior performance by precious metals compared to diamonds. However, investors enjoy greater benefit from directly investing in physical diamonds rather than diamond indices. For investors looking to protect their assets against highly volatile market conditions, precious metals remain a better option. Investors should continue to keep abreast of developments with the evolution of the diamond investments industry and physical diamonds can be included in a portfolio for their downside diversification potential.

Diamonds vs. Precious Metals: What Shines Brightest In Your Investment Portfolio? – Introduction

During times of economic distress, investors are observed to exhibit a flight-to-quality effect, where they rebalance their portfolios towards less risky securities such as fixed income and treasury bills (Abel, 1988; Barsky, 1989; Durand et al., 2010). More recently, investors have been examining the role of precious metals as a hedge or safe haven during highly volatile market conditions. Gold,has been found to possess safe haven properties during extreme volatility in stock markets (Baur and Lucey, 2010). Other precious metals such as silver, platinum and palladium exhibit safe haven properties during periods that gold does not (Lucey and Li, 2013). Aside from precious metals, investments in precious stones have been shown to be effective diversifiers. Auer and Schuhmacher (2013) show that an investment in a diversified diamond portfolio can outperform a diversified stock market investment in a period of generally lackluster stock market performance. Similar conclusions are drawn by Renneboog and Spaenjers (2012) when applying hedonic regression to a unique data set of auction transactions involving investment-grade diamonds. Our work aims to contrast the respective investment performance of precious metals and diamonds during turbulent market conditions and crises across international stock markets. With diamonds being an increasingly valuable and popular asset choice, we investigate if diamonds possess the similar safe haven qualities as precious metals and the possibility that diamonds could supersede them as a superior alternative investment option due the flight-to-quality effect.

Historically gold has always been associated with adjectives such as valuable, expensive, and long lasting. Besides the application in jewelry fabrication and coins, its versatile and stable properties also makes gold a desirable element in technology1 and medicine2. The demand for gold increased drastically after the Global Financial Crisis in 2008, signifying its flight-to-quality characteristics when uncertainty escalates in global markets, and subsequently resulted in a price surge (Biakowski et al., 2015). In 2015, the price of gold has dropped, yet it still remains well above the pre-crisis level. Although demand in jewelry and technology continues to decline, the growth in gold as an investment continues on an upward trend (Street et al., 2015). Diamonds on the other hand, have only been explored as a potential safe haven asset after 2000 (Popper, 2012). Under promotion by aggressive advertising by various diamond retail brands, it has become a symbol for romance and wealth. The steadily growing demand for diamonds poses a serious challenge to the diamond industry, as no major discoveries of new diamond sites have been made over the past two decades (Fischler et al., 2014). As the wealthy and middle-class population continues to expand in developing countries such as China and India, this will eventually lead to a widened gap between demand and supply. Currently diamonds as an investment only accounts for 5% of the entire diamond demand, as it is hindered by the lack of price transparency and market liquidity (Fischler et al., 2014). However, with the evolution of digitalization and online sales, the transparency of diamond prices will eventually be improved (Goodman et al., 2014), thus encouraging more investors to seek the asset as an alternative investment. Low volatility and stable returns are the safe haven characteristics found in precious metal investments, that make it valuable. Thus for investors who value low downside volatility and stable returns due to the economics of low supply and high demand, do precious metals or diamonds work best? More informed decisions can made when investors understand the dynamics between diamonds, precious metals and international equity markets.

Precious Metals

See full PDF below.