Diamonds Are an ETF’s Best Friend?

Thanks to Olivier Ludwig at IndexUniverse for a heads up about IndexIQ’s planned Physical Diamond Trust ETF (and to Tadas @ Abnormal Returns for this post title).  The SEC filing is here, and there are some interesting tidbits.

First of all, any young man who has shopped for a diamond engagement ring for the lady of his dreams knows about the 4 Cs:  Cut, Clarity, Carat, Color.  Diamonds vary in characteristics, and are judged subjectively, although there certainly is a rigorous standard.   I used to live in NYC, where everyone had a “diamond guy.”  Every diamond shopper should experience the Diamond Gypsies of West 47th Street at least once – going from room to room up sets of stairs, behind bulletproof doors, down into boiler rooms – to see the incredibly segmented division of labor in the heart of the diamond district.  You talk to one guy about the stone.  Another guy does the setting.  Then they walk you over to the guy who does the polishing – and none of these little “shops” look like Tiffany’s: they are literally dilapidated closets hidden all over big buildings.   I swear the “polishing guy” was in an old janitor’s closet, but man was that ring spotless when he was done with it

But I digress – back to the S-1.   As regular readers know, ETFs have “creation baskets” which may be exchanged or redeemed for shares in the underlying trust.  With the $SPY, if you deliver the right basket of S&P 500 stocks to the Trust, they give you new SPY shares.  If you deliver SPY shares to the trust, they give you a basket of underlying stocks.  Well, the Diamond ETF (I want to call it DMND but that ticker is taken!) does the same thing.   They will have creation baskets made up a variety of physical diamonds – they call them “diamond parcels.”  The details aren’t exact yet, bu it seems that the basket will be a diverse incorporation of diamonds with different 4C characteristics (ie, 25% G/VS1, 25% F/VS2, etc).  As the S-1 explains:

“Each Diamond Parcel is comprised of [__] diamonds, including that proportion of Subcategory [_], Subcategory [_] and Subcategory [_] diamonds that is in agreement with the Diamond Ratio. At the initial date of deposit, delivery of [_] Diamond Parcels is required for the creation of one Basket.”

It’s the process that I find especially interesting/troubling:

“Each diamond delivered to the Trust in satisfaction of a creation order must be accompanied by a GIA Certification that such diamond meets the Required Delivery Standards of the relevant Subcategory and that it is (i) a mined, natural stone and (ii) not a “conflict diamond”, as defined pursuant to the Kimberley Process. The GIA Certification for each diamond must be dated after January 1, 2006. Pursuant to the terms of the Custody Agreements, a GIA Graduate Gemologist employed or otherwise engaged by the Custodian shall verify the specifications and GIA Certification of each diamond prior to its receipt or transfer as part of a creation order or redemption order, respectively.”

Now what that says is that not only will each diamond be accompanied by its GIA Grading Certificate – each diamond will also be graded by a GIA Gemologist to verify the quality.  For every diamond.  In each creation/redemption order.

It seems that this procedure isn’t so feasible for large creations/redemptions of diamonds.   I guess that having each diamond re-examined can theoretically decrease issues with variance in the initial grading certs, but it also opens up areas for potential issues with subjective grading by the reviewing gemologist, or for fraudulent certifications.

I have my doubts that this product is going to take off – logistical concerns and technical limitations regarding the handling and verification of diamonds in large volumes make me suspect that you won’t see hundreds of millions of dollars in this Trust.  Then again, I am positively not a diamond expert, and maybe there’s something I’m missing: maybe the Diamond ETF will be the panacea that the diamond industry has been waiting for.   I tend to doubt it…

Finally, readers should have no confusion with $DIA – the Dow Jones Industrial Average ETF which is also known as “Diamonds.”

related:

Index Universe: IndexIQ Plans Physically Backed Diamond ETF

SEC: IndexIQ S-1 Filing

-KD

 

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