Diamonds are an investor's best friend

In times of economic uncertainty, many industries feel the pinch of tightened purse strings.

Not so with diamonds.

The luxury stone has continued to go from strength to strength of late, rebounding significantly from its 2008 downturn and today its outlook sparkles almost as brightly as the stones themselves.

Fiona underlines three firms that give investors entry to the sector in: Three plays for diamond exposure.

Analysts at Canaccord Genuity said in a note: "2011 has seen sharp increases in the rough diamond price and, in our view, the price of equities has yet to catch up or significantly re-rate with what has been an exceptional year in the diamond market."

Indeed, at the end of April, average prices of certified polished diamonds were almost 20% higher than a year earlier, while rough diamond prices rose 26% last year and a further 10% in the first quarter of this year.

Deutsche Bank analysts said: "Diamond prices are more an emotional luxury buy than other commodities whose price is a function of scarcity, marginal cost and incentive for new production.

"We think that rising diamond prices are likely as scarcity increases and as consumers in developing economies see prosperity and consumption improving."

Tight supply

Unlike many commodities, diamonds are increasingly hard to come by and exploration has been likened to finding a needle in a haystack.

According to several industry surveys and analysts, the shortage of rough supply is considered the key challenge facing the diamond industry, due to the dearth of new mines and the depletion of those in existence.

John Meyer, mining analyst at Fairfax, told Interactive Investor: "Diamond production is likely to fall off over the next five to 10 years as mines reach the end of their life. This industry is finite; resources will come to an end which poses an ongoing risk to the industry."

But while the hunt for new resources may be on, demand has shown no signs of diminishing. While appetite for the precious stones has improved across developed nations - notably the US - it is the China and India story which really has producers hot under the collar.

Meyer said: "While some investors might be wary of a credit crisis of some sort, there is still very strong growth coming from China and India. We've recently seen hugely strong growth in Hong Kong, which will also serve to help push up diamond prices."

Any concern that the tragic events in Japan would pose a threat to diamond markets has been brushed off, safe in the knowledge that any marginal downturn in demand will be offset by the strong growth across China and India.

This imbalance between supply and demand will, most likely, be met by significantly higher diamond prices, resulting in either an increase in synthetic diamonds or new mine supply. With a typical eight to 10-year lead from exploration discovery to mining, analysts are wary as to how the industry will respond to the shortage in the medium term.

"We see the projected future supply deficit as being closed mainly through a reduction in demand, a situation that appears far from likely to be the case. Indeed, most diamond producers are reporting ongoing strength with exceptional growth in China and India. This bodes well for a market who main demand in the West, but whose growth engine is centres on rising disposable income in the East," said Andy Davidson, metals and mining analyst at Numis.

Asian allure

In fact, China is fast proving to be a diamond's best friend.

Up to 5% of the global market for polished diamond jewellery is coming from China and it is estimated that at the top end of the market for important and fancy coloured stones, up to 50% of the major purchases over the past few years have derived from China and south-east

"China is a key growth market for diamond sales and De Beers has been aggressively marketing engagement rings to Chinese consumers for several years - with good results," analysts at Deutsche Bank said.

And while the large diamonds are a godsend to diamond miners, demand for smaller stones - namely one carat and below - is also increasing substantially from both China and India.

Tim Wilkes, chief executive of London-listed Firestone Diamonds, told Interactive Investor that together, China and India have contributed 20% to the global demand over the past year and will continue to enjoy double-digit growth going forward.

Indeed, Surat in India has become the dominant centre for handling smaller diamonds and has been greatly responsible in recent years for adding value to this end of the chain.

Naturally, with an ever-diminishing supply of diamonds, comes ever increasing prices.

Canaccord Genuity analysts said: "With demand from Asia unlikely to dwindle and a potential restocking in US demand still to come, we believe the structural deficit in the diamond market will only put further pressure on prices."

Wilkes believes the dynamics will mean the industry continues to benefit from rising diamond prices: "Supply and demand is very much in the producers' favour and you can't just switch off fundamentals tomorrow."

Diamond maestro De Beers, one of the world's biggest producers, expects prices for rough diamonds to rise by as much as 20% this year.

This article was written for Interactive Investor

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