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Diamonds: The Crash of the World’s Hardest Currency

 

1979

Despite the need for individual valuation, diamonds have shown a positive and stable price trend over a long period of time. In 1979, however, monopolist De Beers loses control of the diamond market; “investment diamonds” drop by 90 percent in value.

“Diamonds are a girl’s best friend.”

—Marilyn Monroe,
as Lorelei Lee in Gentlemen Prefer Blondes

Precious stones such as diamonds, rubies, sapphires, emeralds, and opals are mainly known for their use in jewelry. Of these, diamonds are by far the largest market segment, and many individual gemstones—for example, the Blue Hope, the Cullinan, the Millennium Star, the Excelsior, the Koh-i-Noor, and the Orlov—have famous histories.

Global production of rough diamonds generally ranges between 20 and 25 metric tons per year. This represents 100 to 130 million carats and is worth approximately 10 billion USD.

Only about 20 percent of all diamonds are used in the jewelry industry, however. Industrial diamonds make up a huge market, and within this segment of smaller stones, artificially produced (industrial) diamonds also play an important role. The largest diamond production sites are in Russia, Australia, Canada, and Africa—in particular South Africa, Namibia, Botswana, Sierra Leone, and the Democratic Republic of the Congo.

The Four Cs in Diamonds

Unlike other commodities, diamonds do not have a standardized fixed value per unit weight. A diamond’s value is determined by various criteria, of which the “4 Cs” are the best known: color, clarity, cut, and carat. Sometimes, a fifth “C” is included. It stands for certification, which confirms the physical characteristics of a particular stone as certified by an official institution.

Color grading depends on how close a stone is to colorless. The classification begins at D—which corresponds to very fine white or almost colorless diamonds—and continues through E, F, G, H (simple white), and so on. Colored diamonds (e.g., yellow, red, blue, or green) are particularly rare, so these so-called fancy diamonds are very precious.

The clarity (purity) of a diamond is determined by the degree of inclusions in the stone. The higher the clarity, the rarer it is. The scale begins with IF (internally flawless) and continues through small to clear and coarse inclusions. Cut refers to the angles and proportions of a diamond. The most popular is the brilliant cut. Finally, traditionally a diamond’s weight is given in carats (1 ct = 0.2 gram).

The largest diamond exchanges are located in Antwerp, Amsterdam, New York, Ramat Gan (Israel), Johannesburg, and London. Antwerp is the most important market; 85 percent of rough diamonds and about half of global cut stones are traded in the Diamond Quarter of that Belgian city.

The value chain begins with mining and includes purchasing agents, processing, wholesalers, traders, intermediaries, jewelers, and other retailers, but a valuation is not simply a linear correlation to size: Larger stones are much rarer and thus exponentially more precious. In addition, prices fluctuate from one size class to the next. For example, the price can vary by more than 1,000 USD from a 0.49-carat diamond to a 0.5-carat diamond, though the difference is only 100 mg or less. In December 2018 prices for 1-carat diamonds ranged from 500 USD to 10,000 USD, depending on the degree of purity and colorlessness.

By far the most important player in the diamond industry—analogous to OPEC in the global oil market—is De Beers. The South African company, part of the Anglo American mining group, is the largest diamond producer and trader in the world.

Figure 7. Diamond prices, 2003–2016. Prices indexed over different sizes and qualities. Data: PolishedPrices.com, Bloomberg, 2019.

De Beers has long dominated the global diamond market, similar to the way OPEC dominates global oil.

De Beers controls about 30 percent of the world’s diamond production, and its influence in marketing and sales is even stronger. The company determines the volume and quality of rough diamonds that traders are able to buy. The Diamond Trading Company (DTC), which is controlled by De Beers, buys most of the world’s raw diamond production, allocates production quotas to mining companies, and manages sales through the Central Selling Organization (CSO), which is also an extended arm of the DTC. The CSO regularly organizes “sights” in London where about 150 authorized sightholders are offered compilations of rough diamonds for sale.

For years the De Beers Syndicate guaranteed stable prices. At the end of the 1970s, however, the company lost control of the diamond market.

A De Beers Primer

De Beers, the largest diamond producer and trader in the world, has been active in the diamond market for more than 100 years. The company’s name goes back to the first mine in Kimberley, which was located on the farm of brothers Johannes Nicolaas and Diederik Arnoldus de Beer. After diamonds were found there in 1871, a group of adventurers transformed the remote place into the world capital of diamonds. British businessman Cecil Rhodes gradually bought up all the mining licenses and founded De Beers in 1888. Today, the company is 45 percent owned by the Anglo American Corporation, with 40 percent owned by the Oppenheimer family.

Ernest Oppenheimer was born in Friedberg, Germany, near Frankfurt am Main, in 1880, and at age 32 he was pulling the political strings in Kimberley. In 1916, Oppenheimer founded Anglo American, which quickly became one of the most successful mining companies in the world. In 1926, he took over the majority of De Beers.

De Beers’s entire production was always bought by the London Diamond Syndicate, which was established in 1890. The syndicate was the cornerstone of the Diamond Corporation, precursor to the Central Selling Organization (CSO). In the 1930s, during the Great Depression, Oppenheimer bought up massive quantities of diamonds in order to stabilize prices. Since then, De Beers and CSO have formed an exclusive diamond cartel.

During that decade the US dollar depreciated significantly against other currencies, due to rising inflation in the United States and a search by investors for nontraditional investment opportunities. Interest in diamonds as a “hard” currency and a stable store for wealth increased, leading to greater demand for high-quality stones. De Beers, however, only moderately expanded the supply at the time, which resulted in further price increases that, in turn, attracted more and more potential investors.

Diamond hysteria took hold. In 1979, the value of investment diamonds doubled, and prices for a 1-carat diamond of the best quality increased tenfold.

Meanwhile, in Israel, rough diamonds were also becoming a favorite investment. In order to support Tel Aviv as an emerging center of diamond processing, the government granted large loans to banks under favorable conditions. As a result, a number of diamond investment companies were set up, which were able to sell diamonds directly to private investors.

The hysteria over investment diamonds fueled a vicious circle. In 1979 the average price for diamonds doubled. Prices for a 1-carat, best-quality diamond multiplied by 10 and for a while traded at around 60,000 USD!

De Beers attempted to gradually cool the market by expanding the supply, but the strategy was unsuccessful. The result was complete market chaos. The inevitable bust finally began in Japan, where it was common practice to accept diamonds as collateral for loans. When the first bank considered the market overheated and stopped accepting diamonds as collateral, the house of cards collapsed. The first drop in prices kicked off a race to sell stones. As speculators disposed of their stock, more and more borrowers fell below their collateral limits and were forced to raise money. Diamonds flooded the market, which was already oversaturated by De Beers’s efforts to cool it down. Even a cessation of sales and a buyback of diamonds by the cartel didn’t help. Prices crashed, and investors’ net wealth decreased, a downtrend accelerated by global recession.

Within a year, the prices of investment diamonds fell from 60,000 to 6,000 USD.

Within 12 months, the price of investment diamonds fell from 60,000 to 6,000 USD, approximately the level before the hysteria started. After that diamond prices recovered slowly, although in the early 1980s, the CSO withdrew diamonds worth more than 6 billion USD from the market, while De Beers cut mining quotas and closed one of its mines in South Africa. De Beers took similar actions to stabilize the price of diamonds after the global financial crisis in 2009, which had lessened the demand for luxury goods.

Key Takeaways

•South African company De Beers, today part of the Anglo American mining group, has long dominated international diamond production and sales.

•In 1979 the company lost control of the diamond market after a market frenzy, during which average diamond prices doubled within a year, and prices for a 1-carat best-quality diamond rose tenfold, only to crash by 90 percent after the bubble burst.