Choosing your diamond part 3

Isaac Mostovicz writes...

Diamonds are truly priceless

It took me many years to understand how diamonds are priced and what a “good price” for luxury goods and diamonds really means. You will not find this information elsewhere as the subject was never researched and assumptions about pricing were never examined.

We have always been told, following the basic assumption in economics that prices are the result of supply and demand. The higher the demand, the higher the price is and the more the supply, the lower the price. Without challenging this assumption head-on, I can testify that the diamond industry does not follow this basic formula or any adaptation of this assumption anywhere in its entire supply chain.

In general, we have three systems of pricing: the pricing of rough diamonds, the pricing of polished diamonds within the pipeline and the price of the polished diamond for the consumer.

Each system of diamond pricing reflects the needs of the particular market but none follows the supply/demand assumption.

The main problem of the rough mining companies is the enormous long-term investments that involves in developing a mine. Apart from the expensive exploration process, when a diamond mine is found, it takes many years until it becomes fully operative. To make the Venetia mine, one of the largest in South Africa, operative it took ten years for De Beers, the world’s most efficient mining company, to accomplish. Even when the mine is fully operative, it is very expensive to operate. Diamond mines are the world largest earth movers and we measure a yield of a mine by carats (1 carat = 0.2 gram) to 100 tons of gravel.

On average, we need to earth ten times the Wembley or the Shea stadiums to get one 1 CT diamond of the D IF quality.

So as to reduce the risk involved in such a long-term investment, De Beers followed by other producers developed a system that, when applied can indicate clearly the value of the diamonds to be mined. This information is relatively stable as well as the life of the mine. Thus, while the mining companies have to invest vast amounts of money over many years, they are able to predict the level of production and, consequently, their revenues.

The system that De Beers uses is based on a 5000-categories price list. This price list is based mainly on the relative rarity of various diamonds but it takes into consideration the diamond’s shape, quality, difficulty to manufacture and other factors. You can get similar polished diamonds out of different-in-price categories.

The pricing system that the polished-diamond industry uses is complicated as well. On the one hand, it is based on relative rarity – the larger, whiter and cleaner the diamond is, the more expensive it is. The shapes plays a role as well as round diamonds are usually more expensive than other shapes. The other element involved in the pricing system is risk. There is no guarantee that a certain diamond will be sold and people buy diamonds into their stock with the hope that they will be sold eventually. Thus, the price of the diamond that is based on its relative rarity is discounted to reflect the risk of not selling it. When the market suffers from sever illiquidity, the risk of not selling is higher and prices drop. In an active market, the discount becomes smaller and the gap between different quality and rarity categories increases. Unfortunately the diamond industry is far smaller that the market of options and derivatives and the Black-Scholes formula was never applied in the diamond market.

How about you, the consumer? Are any of these considerations concerning you? I doubt it. Is there a fair price for diamonds? I doubt it as well. After all, if you buy a diamond that you cannot enjoy, you just wasted your money.

All you have to check is whether you are happy to spend on your loved one the amount that you are asked for and whether she is going to be happy with what she is going to get. If the answer to both is “yes”, go ahead and enjoy your spending.

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