Diamond futures may be on their way back as exchange-traded instruments, group says

Diamond futures may be on their way back as exchange-traded instruments, group says

The Associated Press
Published: September 17, 2007

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NEW YORK: If plans come together, diamonds may become a trader’s best friend.

Investors have been using futures and derivatives contracts in metals, agricultural products, currencies and other risk-related investments to hedge against losses for decades.

Now, a group is trying to add diamond contracts to the list of exchange-traded instruments.

The Rapaport Group, a diamond price and information provider, will hold the first of planned monthly online diamond auctions Monday through Thursday. Transaction prices will be used to create an index in hopes of developing a diamond futures market.

“We’re creating a new level of transparency for diamond prices,” said Martin Rapaport, chairman of the Rapaport Group. “It’s going to open up a cornucopia of opportunities for the diamond market.”

Bidding will be for 210 lots, each lot a single stone, and will be open to the diamond trade and financial institutions. Consumers can access the auction via a registered market participant. Auction terms will be spot cash, free on board, with a 3 percent commission charged to sellers, who will be paid within five business days of the auction’s close.

All the talk about diamond derivatives isn’t new.

In 1972, 194 diamond contracts were traded on the West Coast Commodities Exchange over a two week period before prices collapsed and the exchange ended diamond futures trading, according to the Diamond Registry, quoting author Edward Jay Epstein.

“It’s been tried before,” said David Prager, director of communications for DeBeers, the world’s largest diamond producer. “Let’s see what happens, but there’s not an opinion from DeBeers.”

Diamonds, similar to other commodities, are tied to wider economic indicators like consumer demand and inflation, Rapaport said.

Critics say diamond futures would be hard to price because each diamond is unique, unlike, for example, gold bullion in standardized quantities and purity.

The auction will track prices for one specific type of diamond and later may branch out to other types, Rapaport responded.

Another critic, whose company is competing against Rapaport to create pricing for future exchange-traded contracts, also has qualms about the auction.

“I really don’t buy into the concept of using a tender to set the market prices,” said Charles Wyndham, founder of PolishedPrices.com, a diamond price and information platform.

“To start coming out and saying this is going to be transparent and a base for a derivatives market, I just don’t see it,” Wyndham said. “Are his mates bidding for the stones to create a market?”

Rapaport said tender offers are good ways to create an index for a futures market because they involve multiple buyers and sellers who are under no compulsion. The auctions will provide spot cash transaction prices, not just asking prices, he said.

“Auctions are a clear, crispy crunchy vehicle to observe,” he said. “It’s free, open, competitive, efficient markets. We know who the buyers and sellers are. There are real buyers and real sellers.”

He added that when Rapaport moves to the futures market stage, the group will go through regulators.

“At this stage I think this is a perfectly legitimate auction,” Rapaport said. “We are not trading any stones, we are not buying or selling anything.”

Rapaport said there are “absolutely” no conflicts of interest with the diamond auction. The Rapaport Group serves as a broker and clearing house but “we don’t own any of the product.”

The group will only progress to the futures market stage if the trading can be inclusive, transparent and receive regulatory approval, Rapaport said. If all that gets done, diamond futures contracts could begin trading in two years on an exchange.

Wyndham said PolishedPrices is coming along with its own plans for a diamond derivatives market.

“We’re in discussions with a particular exchange,” Wyndham said. “We haven’t signed any papers or anything.” He declined to identify the exchange or its home country but said the company has done due diligence.

Wyndham said PolishedPrices has been approached by several exchanges, including the Chicago Board of Trade.

“They did contact us,” he said, adding that a CBOT representative made a presentation at a meeting about diamond contracts organized by PolishedPrices in Antwerp in June.

Mary Haffenberg, spokeswoman for CME Group, which recently bought CBOT, declined to confirm whether that presentation took place or any products the exchange may roll out in the future.

“We are always looking at new products based on customer demand,” she said.

Wyndham envisions PolishedPrices’ role as a supplier of a wholesale cut diamond price list based on multi-source priced transactions that could be used to create an index sponsored by ABN Amro, a large lender to the diamond industry.

“There’s going to be some form of derivative contract within 12 months, probably sooner than that,” Wyndham said, citing figures from India’s ICICI Bank that the market for diamond derivatives could reach $150 billion (€108 billion) to $200 billion (€144 billion). ABN Amro — which was at the June meeting in Antwerp along with ICICI, according to Wyndham — says there is “tremendous” pressure from the outside investment community for the investment option.

Such a contract would allow the industry to manage risk, and diamonds are the only significant commodity not traded with futures and derivatives, Wyndham said. The contracts would also provide investment opportunities for outside investors, creating liquidity for the diamond industry, he said.

An ABN Amro representative who could speak on the diamond industry couldn’t be reached for comment, nor could an ICICI representative.

A representative from DeBeers was also at the meeting, but didn’t make a presentation, Wyndham said. DeBeers deals in rough stones and any futures contracts would likely be for cut diamonds, he said.

Rosalind Kainyah, director of public affairs for DeBeers, said it isn’t clear how diamond derivatives would work since each diamond is unique.

When asked if DeBeers is concerned such markets could affect its pricing scheme, she said: “It’s a hypothetical question that’s difficult to answer.”
       
Matt Whittaker is a correspondent of Dow Jones Newswires

Rival attacks Rapaport’s diamond plan
By Michael Bleby in Johannesburg
Published: September 17 2007 03:00 | Last updated: September 17 2007 03:00
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Martin Rapaport, founder of the world’s largest diamond-trading platform, will this week begin the open diamond tenders that will pave the way for a regulated futures market by the start of 2009. But his main rival says it will not work.

The four-day auction that starts today marks the start of the monthly internet-based sales of individual stones that Mr Rapaport’s New York-based company hold. Data from these tenders will form a pricing index from which he plans to develop diamond-based futures contracts overseen by the US Commodity Futures Trading Commission.

Derivatives for commodities such as gold and pork bellies have long existed, but the absence of reliable pricing data so far has held up their application to diamonds. The huge variation in value between different stones is part of the problem. But appetite for diamond derivatives is strong, with a market worth $200bn a year by some estimates.

“When you break that wall between the financial sector and physical diamond sectors, a cornucopia of opportunities is going to open up,” Mr Rapaport says.

Transparent pricing would end the secrecy that has until now decided prices behind closed doors. It would also remove resale opportunities for the many intermediaries found between manufacturer and retailer. Diamond derivatives would allow retailers and manufacturers to hedge against future needs – important, given the surge in demand from India, China and the Gulf region – rather than buying up large inventories to ensure supply. Industry debt has doubled in the past four years to more than $12bn, largely through the buying-up of inventories.

Nonetheless, Mr Rapaport’s system is “intellectually flawed”, says Charles Wyndham, founder of website polishedprices.com, which publishes price data from a number of diamond traders and is separately in talks with ABN Amro bank to create derivatives.

The narrow range of stones Mr Rapaport will offer in his September tenders – those of one-carat in size and certain grades – will not permit extrapolation of prices for all stones or take into account the weighting of different types of stones according to their frequency, Mr Wyndham says. Tenders are also susceptible to manipulation, he says.
Mr Rapaport says it is easy to spot distortions in a tender process. He concedes that his system does not solve all the problems, but says it is a start. “The imperfection here is real. It begins the process of mitigating issues of risk management and finance,” he says.
Copyright The Financial Times Limited 2007