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Why the emergence of the diamond financial market might not be far away

As a researcher, currently finishing my PhD in Finance/Commodities at the Sapienza University of Rome and a GIA scholarship recipient, studying for a Diamonds and Diamond Grading Diploma, I have embarked on a wide ranging research project examining the characteristics of potential financial derivatives for diamonds. 

The findings to date of my research provide interesting insights into the potential of diamonds linked to financial products, similar to other commodities.

This article aims to share some of my findings, considering the increasing importance of the financial aspect of the diamond industry.

Firstly, I constructed a system for diamond pricing based on two pricing indices. The first index was a “bundle” of representative diamonds, creating a possible product for futures on diamonds. The second index was a dynamic-weighted average pricing index, which calculated an average diamond price level by including the prices of all traded diamond categories (all traded combinations of carat weight, color and clarity grades). The price of each category was included in the average price with a percentage weight equal to the percentage of that category’s traded volume in relation to the over-all diamond traded volume. These percentages change every year according to how the traded volumes of specific categories changed. The final average price at a specific time point was calculated by multiplying all categories’ prices by their corresponding weights and summing them up. 

The real pricing data, based on actual transactions from polishedprices.com, were applied in calculating indices’ values to create monthly/weekly historical time series (2002-2014). 

After examining the summary statistics for the two indices, I evaluated the possible correlations between them and macroeconomic variables (US CPI, US GDP Index, US Manufacturing Index, Chinese GDP Index and different Exchange Rates and Interest Rates). These correlations are important in examining whether the diamond prices move along with business cycles and whether the changes in exchange rates or interest rates could predict diamond prices changes. I used monthly data for diamond indices and macro-variables and a 20 months window rolling correlation. I found no substantial or lagged correlation between diamonds and selected macroeconomic variables. This finding suggests that diamonds could represent a safe asset in uncertain times, performing differently than the over-all economic indicators.

Furthermore, I calculated the correlations between diamond indices and different commodities, stocks and bonds by using weekly data log-returns in DCC-GARCH estimation of dynamic correlations. 

I found no correlation between diamonds and alternative assets, signifying that diamonds could indeed be a  ‘safe heaven’ or a good portfolio diversifier. Additionally, I estimated risk-adjusted performance, by analyzing the returns on diamond pricing indices in relation to their risk. Diamonds seem to be an attractive financial asset for risk-averse investors. Different portfolio fittings were also applied by including diamonds as an asset class into different portfolios and examining how the portfolio’s financial power changes with diamonds included. 

To estimate the risk of diamond investing, I examined the volatility of diamond indices and sub-indices and compared it to the volatility of alternative assets. I found substantially lower volatility in the case of dynamic-weighted average pricing index. This index, hence, represents a very good solution for risk-free investing, as, unlike the bundle index, its volatility is so low that it is comparable to the volatility of bonds.  

Moreover, I constructed two diamond stock indices and compared the investing into diamond derivative products versus diamond companies’ stocks investments. 

Additionally, my team built a neural network model that predicts diamond indices’ values based on their historical values. The model is based on ‘machine learning’ and uses historical values as inputs in the algorithmic system to predict the future values with high probability. The ability to forecast indices’ future values with high degree of probability could raise price transparency and increase the investors’ confidence.

Finally, my research also examined the market of high-end diamonds, both white and fancy colored. Namely, by using sophisticated econometric techniques, I was able to identify the pricing mechanism of auctioned high-end diamonds and calculate the price effects of their different characteristics. 

Diamonds could be a very promising financial asset due to many favorable characteristics (easy to transport, ‘zero’ cost of storage, non perishable, uncorrelated to alternative assets, possible price-appreciation in the near future, store of value, safe heaven). 

Based on the findings, I believe that financial trading of diamonds is only a matter of time, as long as the diamond financial market is wisely structured, properly standardized and based on graded and certified diamonds. 

If you have any questions or comments, please contact me on vera_jotanovic@yahoo.com.

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