Rapaport Magazine
Op-ed

Big Stone Boom

By Martin Rapaport
RAPAPORT...Big, expensive diamonds are booming. The 5-carat round D, IF is up 51 percent this year at $106,500 per carat on the Rapaport Price List. Ten carat and larger D-F, IF-VVSs and Fancy Intense/Vivids are too hot to handle. Prices are through the roof and out of control. Why is this happening? Is this a speculative, big bubble boom? Are these prices sustainable? Is today’s boom tomorrow’s bust?

Diamond prices, like all prices, are subject to the laws of supply and demand. The challenge for us is to identify and understand the unique characteristics and interactive dynamics of diamond supply and demand. Diamonds are not a “normal” fungible commodity. While large, expensive diamonds and small, inexpensive diamonds are not a substitute for each other, similar diamond categories do offer easy demand substitution, flattening and delaying price increases. A consumer for a large, expensive diamond might shop freely within a 5-carat and larger D-G, IF-VS1 zone with many possible size/quality combinations for that special diamond.

As global wealth began expanding (see “Globalization,” RDR, December 2007, page 3), big diamond prices increased at a relatively reasonable rate. Specific items did not move up too rapidly because buyers were able to substitute one magnificent diamond for another. However, at some point, the supply of big diamonds diminished to the point where dealers could not replace stones and buyers could not find easy substitutions. Given the fact that larger diamonds are natural and scarce, the trade could not just crank out more stones. Supply was not available, demand hit a brick wall and prices reached a boiling point.

The tight supply of large diamonds created a fundamental shift in the psychology of sellers and buyers. An alternative market model with exponentially greater price traction developed. Diamond manufacturers and dealers quickly realized that, with limited supply and strong demand, they did not have to seek out buyers or provide diamonds to retailers on memo. Diamond buyers would beat a path to the supplier’s door and give them much higher “retail” prices. It made business sense to hold back diamonds and wait for higher prices.

For normal commodities, demand decreases as price increases. Not so with large diamonds — a conspicuous consumption product. As diamonds become less available and prices increase, wealthy buyers want them more. This may be because people want what they cannot have more than what they can have. It may also relate to the basic psychology behind a type of demand where the woman wants the man to spend a “serious” amount of money on her because she projects the value of the diamond onto herself and their relationship. Furthermore, the exclusivity of owning something your quasirich neighbor can’t afford is also worth something. Finally, as prices increase, two great marketing motivators kick in: “buy it now before prices go up more” and “it’s a good investment.” The bottom line is that for really wealthy people with extra millions and billions of disposable income, it really does not matter how much a big diamond costs. You can’t tell the wife of someone with an extra $30 million in the bank that she can’t have a big diamond because it costs too much.

So now that we understand the dynamics of big diamond prices, where does it lead? When will the bubble burst?

As long as demand exceeds supply, prices will continue to rise until wealthy consumers prefer other products. Given the stickiness of diamond demand driven by the universal appeal of the diamond dream, magnificent pieces with high-quality smaller diamonds may provide an opportunity for demand substitution and price increases for smaller sizes.

If and when the unpredictable and volatile external market forces creating wealth dissipate, demand will slacken and prices will fall. The strong winds of change that have puffed up diamond prices could easily change direction and blow away price gains.

A few words about speculation: We should not blame the diamond trade for opportunistically managing their inventory to maximize profits. Barring collusion, market players should be free to balance risk with opportunity. Market players should realize that the imbalance between rough and polished prices represents gambling on future prices and that current polished prices partially reflect artificial shortages created by dealer hoarding. Gambling on big stone prices is not very different than gambling on stock markets or commodities. If you do not have enough capital to sustain a downturn, you will not have a chair when the music stops and you will go bankrupt.

In conclusion, powerful and volatile external market forces beyond our control are moving big stone markets. Real demand confronting real shortages is creating real prices. The actions of speculators are a sideshow. The real story is about global wealth and the economic forces creating it. The diamond industry does not control diamond prices. We are a ping-pong ball in the ocean of the global economy and must learn to ride the waves.

Article from the Rapaport Magazine - January 2008. To subscribe click here.

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