Each year in the storied town of St. Moritz, Switzerland, some of the world’s wealthiest jewelry collectors converge on the stately Kulm Hotel for the annual Sotheby’s winter jewelry sale. Unlike a Boxing Day or Black Friday sale, however, this sale lacks any door crasher specials, all-night line-ups and inevitable stampedes when the doors open (we assume – although none of us have actually been there).
Buyers at this auction, and at Christie’s equivalent in St. Moritz, are looking for some serious bling. But they’re also cognizant of the investment value of their purchases – particularly when it comes to diamonds. Like gold, diamonds are easy to transport stores of hard value (just as Ernst Blofeld, the diabolical genius in the movie Diamonds are Forever, who tries to build a deadly satellite-based laser using smuggled diamonds).
So how do diamonds stack up against other investments? That’s the question Luc Renneboog and Christophe Spaenjers of Tilburg University recently asked themselves. They found that despite the success of Diamonds are Forever, some 40 years ago, there remains “no information…on historical investment performance of gems.” Thankfully, the duo hooked up with diamond appraisal firm Rocks International and got access to the firm’s database of nearly 4,000 auction gem sales around the world (mainly in Geneva, New York, Hong Kong, and of course, St. Moritz). The result of their work is contained in a paper published in April called Hard Assets: The Returns of Rare Diamonds and Gems.
According to Figure 1 in their paper, it looks like so-called “coloured” diamonds (red) are rising in price faster than their white (blue) cousins.
But wait: Unlike gold, diamonds are a heterogeneous universe. You can’t really compare two transactions. You’d have to establish some kind of regression model to account for all sorts of factors such as quality and size.
While some argue that setting up such an index is like trying to have an “index for snowflakes”, Renneboog and Spaenjers contend that you just need to regress these transactions against the right variables. They start with the “Four C’s” (all too familiar to married males out there) and add factors like the location of the auction and the auction house used (Sotheby’s or Christie’s). They even account for the fact that some diamonds have a potential to be further upgraded by recutting or repolishing.
The result of these regressions is shown in the chart below (Figure 3) containing “real index values” for the prices of white and coloured diamonds.
It turns out that white diamonds have a much lower volatility than either coloured diamonds or equities. (Chart below crated with data from Table 5.) According to the data in this study, the Sharpe ratio for white diamonds are roughly the same as the Sharpe ratio for corporate bonds. (Gold smokes all other assets because the horizon is the past ten years.)
But what might really interest the attendees at the St. Moritz jewelry auctions is the fact that diamonds have a pretty low correlation to equities. Sure, it’s not as low as bonds or gold, but higher returns (vs. equities), the same or lower volatility (than equities) and a low correlation (to equities) has got to raise a few eyebrows amongst the (snow)polo-playing, fondue-eating jet setters who converge on St. Moritz each winter.
Maybe Ernst Blofeld should have just kept the smuggled diamonds and cashed them in someday at auction. Then again, why wait to get rich when you can secretly launch a satellite, invent a gigantic laser, blow-up the world’s nuclear arsenal and then auction off your weapon to the highest bidder? Now THAT has some serious investment potential.