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Diamonds Are Now an Institutional Asset

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Diamonds Are Now an Institutional AssetDiamonds Are Now an Institutional Asset

Written by: Cormac Kinney | The Diamond Standard

A Survey of Research Relating to the Diamond Standard Commodity

  • Breakthrough: A fungible diamond commodity enables institutional use, transparent price discovery of 16 million geological varieties of diamonds by a market maker. No estimates, surveys or subjectivity are used in the standardization process.
  • A delivered physical commodity, in the form of a standardized coin or bar, like gold, is a stable store of value, with a daily market fix. Each asset contains an exchange-sourced publicly-audited set of natural diamonds, statistically calibrated by geological scarcity.
  • The physical commodity features digital audit, authentication, and secure and efficient blockchain transaction technology, using an embedded wireless encryption chip.
  • Unprecedented regulatory approval and oversight.
  • Diamonds are a $1.2 trillion natural resource, uncorrelated to gold, stocks and bonds. A hedge with high return vs. stocks and bonds, during previous recessions.
  • Commodity solves constraints to use of diamonds by investors and asset managers: standardization, fix price, price discovery, low transaction friction, and liquidity.
  • Diamond commodity liquidity and price discovery will be further enhanced by forthcoming futures, options and a physical ETF.
  • Traditional demand estimated at $180-300 billion, based on 15-28% holdings by investors, of gold, silver, platinum and palladium.
  • Diamonds are at a multi-year low price, vs. gold at multi-year highs—while investors seek hard assets, deep into the longest ever bull market.

Diamonds—The Inaccessible Commodity

For decades, investors have sought to utilize diamonds as an investment asset. Diamonds are extremely attractive — and not just because they are beautiful:

  • Supply-constrained, long demanded, permanent natural resource
  • Extremely dense value concentration, around $400,000 per ounce
  • Deep, stable asset class: $1.2 trillion above-ground and $30 billion per year production
  • Approximately 2.5% stock-to-flow ratio, similar to gold
  • Global supply and demand for jewelry and industrial applications
  • Hard asset historically uncorrelated to stocks, bonds, gold and other commodities
  • Strong performance during two recent recessions — outperforming stocks and bonds

But diamonds have never been a liquid commodity due to several challenges:

  • Extreme variations between stones, with no standardization or fungibility
  • Non-linear values based on quantitative, qualitative and subjective diamond factors
  • Former cartel control—supply chain dependent on retail markup and price secrecy
  • No market price, price discovery mechanism, regulatory oversight, or transparency
  • Immense liquidity discount and transaction friction (i.e. auction fees)

Several factors make 2020 “The Year of the Diamond”

  • Growing investor demand, seeking hard assets to provide diversification, returns, and hedging—ten years into an unprecedented bull market
  • Diamond prices at a 10 year low, primarily due to market credit issues, not supply or demand fluctuations
  • Technological advances: automated market making, statistical arbitrage, optimization and blockchain, led to the invention of the fungible and fair diamond commodity
  • Launch of the Diamond Standard commodities : the world’s first fair, fungible and transparent diamond commodity, with a daily market-determined fix price
  • The Diamond Standard Coin is launching in Q2 2020, with an initial offering that will calibrate the permanent diamond content, via reverse auction

Establishing the Diamond Standard

  • The Diamond Standard commodities consume graded natural diamonds of every quality between 0.25 and 1.99 carats, in proportion to their geological scarcity.
  • This constant demand for every diamond quality establishes Diamond Standard Co. as the world’s first market-maker for loose diamonds
  • Diamond Standard Co. will make transparent bids for 16 million varieties of diamonds, on the regulated, member-governed electronic Diamond Standard Exchange
  • Using automated market-making technology, Diamond Standard raises its bids to the degree necessary to purchase statistically valid samples of all diamonds
  • This process instigates price discovery for the “least-cost-to-deliver” diamonds of every quality, on a continuous basis
  • The Diamond Standard, the median of the statistically valid samples, never changes, and the diamonds are sorted into equivalent sets by an optimizer—every set is public
  • The result is a standardized commodity, comprised of varieties of diamonds, in aggregate within 2% of a permanent median—with public data for mathematical proof
  • The standardized Coin and Bars are fungible, with a single market-determined fix price
  • Standardization dramatically reduces transaction friction, and increases liquidity
  • Diamond grading, sorting and assembly by the Gemological Institute of America
  • Diamond Standard Exchange, with custody and global settlement by the GIA, is disintermediating the diamond supply chain, reducing supply chain cost
  • See the Diamond Standard White Paper for a detailed presentation

Diamond Financialization and Regulation

  • Diamond Standard Co., as an arms-length market-maker (buying but not selling), instigates transparent price discovery for all varieties of loose diamonds, up to 2 carats
  • The Diamond Standard Coin (initial index price $10,000) is expected to launch in early 2020, followed by the Diamond Standard Bar in late 2020 (initial index price $100,000)
  • The physical commodity will trade on spot exchanges. These are expected to include digital currency exchanges in the U.S., and digital and commodity exchanges globally
  • The VWAP (volume-weighted average price) of key exchanges will be the daily fix price
  • Diamond Standard Co. is principal dealer of the commodity, but not a market-maker.   It sells new commodities at the fix established by the trading in the secondary market

Regulatory Oversight

  • The Diamond Standard Commodity is not a security, it is a delivered physical commodity
  • The U.S. regulator of physical commodities is the Federal Trade Commission, enforcing delivery, weight and purity. The F.T.C does not oversee investment products
  • The U.S. S.E.C. and C.F.T.C. do not regulate the primary sale of physical commodities, like Diamond Standard’s—they regulate exchanges and derivatives respectively
  • Diamond Standard sought a regulator, and selected the Bermuda Monetary Authority. It supervises, regulates and inspects financial institutions and exchanges, and under the 2018 Digital Assets Business Act, companies utilizing the blockchain like Diamond Standard, to ensure compliance with international standards
  • Upon the issuance of a license by the Bermuda Monetary Authority, it will oversee
  • the segregation and protection of investor funds during commodity production
  • the delivery of statistically valid samples of diamonds to the GIA
  • the enforcement of FATCA, KYC & AML compliance
  • the issuance of digital asset tokens integrated with the commodity, for audit, authentication and transactions on a number of blockchain platforms
  • internal audit by Deloitte of the commodity issuer operations
  • When the traded on an exchange, the spot commodity transaction is subject to the oversight of the regulator or state commission pertinent to that exchange

Near Term Financial Instruments

  • C.F.T.C regulated futures contract will follow the physical commodity spot trading
  • Physical asset ETF will be filed with the S.E.C. in mid 2020, followed by international ETFs

Diamonds as a Diversification and Hedge

  • Low-negative correlation to gold, and low-positive correlation to USD (Auer 2013, 2014)
  • No correlation to stocks, even diamond mining stocks (Jotanovic 2018, 2019)
  • Diamonds are an effective diversifier to other commodities (Spar 2006, Low 2016)
  • Noteworthy: Gold is at a multi-year high, while diamonds are at a multi-year low

  • Historically, diamonds have exhibited no correlation to, and far lower volatility than other major commodities (Spar 2006)

Historical Returns of Diamonds

  • Between 1999-2010, a period with two recessions, diamonds returned 6.4% annualized in real USD terms, outperforming stocks and bonds (Renneboog 2012)
  • Between 2003-2012, diamonds returned 10% annualized in real USD terms, outperforming stocks and bonds, and within 2% of gold (Renneboog 2012)

  • Between 2015-2019, diamonds substantially underperformed gold, stocks and bonds

Diamond Demand Analysis

  • 15-28% of the global supply of fungible precious metals—gold, silver, platinum and palladium—are held by investors as a store of wealth
  • With an above-the-ground market value of $1.2 trillion (Zimnisky 2013), (4x the value of platinum), 15% of diamonds, or $180 billion, is the baseline traditional-demand
  • Combined, BlackRock, Vanguard, StateStreet, Invesco, Putnam, Barclays, JP Morgan, Nomura, UBS, Fidelity, Allianz, BNY Mellon, AXA, Goldman Sachs, Credit Suisse, BNP Paribas, Van Eck, T. Rowe, WisdomTree, Morgan Stanley, Deutsche Bank, Northern Trust, Wellington, and Prudential own a grand total of zero diamonds
  • Unidirectional filling of institutional allocations to diamonds may take 7-15 years
  • As the bull market for stocks and bonds extends to an unprecedented eleventh year, investors cite recession concerns, and an interest in uncorrelated hard assets

The Digital Asset Use Case

  • Diamond Standard Commodity contains technology to audit, authenticate & transact
  • The only physical commodity that can asset-back smart contracts or digital currencies
  • Diamonds are the only natural resource that has the dense value and crystal structure, in order to be deliverable, portable, easy to authenticate, audited and decentralized
  • Diamonds could be the ideal reserve asset for the future of digital currencies, creating demand beyond the expected 15-19% ordinarily sought by hard asset investors

Related: A Liquid Commodity for Diamonds with Cormac Kinney

References

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