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Retail investment in 2022: Gold vs diamonds

27 december 2021

Inflation in the United States has broken a multi-year record as the consumer price index rose by 6.8% year-on-year in November this year, hitting a 30-year high. In an attempt to counteract this threatening trend, the Fed has intensified its implementation of the quantitative easing reduction and promises to completely stop the liquidity injection in March 2022, and not in June, as previously planned. It is also expected that the interest rate on federal loan funds in 2022 will be raised to 0.9% from the current range of 0% - 0.25%.

A decreased flow of cheap liquidity against the backdrop of a record inflation will inevitably lead to serious turbulence in the stock market, and many sectors will face a serious drawdown. These expectations have already influenced the insider sales: according to the Insider Score, the insider sales in January-November 2021 exceeded those in 2020 by 1.5 times. While the top managers and majority shareholders of the major companies are vigorously unloading record quantities of stocks, the ordinary retail investors are paying increasing attention to the assets that theoretically make it possible to hedge the risks of potential collapses in stock markets.

First of all, it is, of course, physical gold in bullion and investment coins. This year, the US citizens bought over 90 tonnes of gold in bullion and coins, which is almost 80% higher than last year. In China and India, the sales increased by 54% and 24%, respectively, in Russia - by 8%. The moderate appetite of the Russian investors is partly explained by the 20% VAT on gold bars (there is no VAT on investment coins in Russia), while, for example, in Europe this tax is zero. However, it is quite possible that in 2022, the VAT on gold bars will be abolished in Russia, which will increase the Russian investors’ interest in physical gold. In the meantime, Russia satisfies the needs of foreign investors by exporting almost all the gold produced in the country, and for three quarters of this year, the gold exports exceeded 240 tonnes and the production totalled just over 250 tonnes. Moreover, the exporters of Russian gold are exempt from the obligation to place their revenues to their accounts in the Russian banks.

In the current conditions, the interest of investors in gold is quite obvious and justified. Here is a chart of the stock exchange prices for gold over a five-year period (vertically: the cost of a troy ounce in US dollars):

excl_20122021_2.png

The Bullion Rates data

Январь – January.

An over 50% growth of the asset over five years is quite a decent result that allowed the investors in physical gold to compensate for inflation and to earn decent money. The great merits of this asset include its fractionality, i. e. the ability to hold an asset in fairly small units and sell in parts as needed (a huge advantage over the real estate), and its practically perfect liquidity. It is quite simple to buy and sell the investment gold coins and bars, the price of which is linked to the stock-exchange quotation of gold through specialized licensed companies in any advanced economy. The bid and asked spread (difference between purchase and selling price) usually ranges from 2%-5% and depends on the country of the transaction and the actual demand for coins of certain issues. It is not uncommon for a coin issued, for example, five years ago, to be purchased today at a price that exceeds the current stock-exchange quotations by two percent. The tax laws applicable to the investment physical gold transactions differ from country to country, but are generally more encouraging for a retail investor. In Russia, for example, the investors who have held investment coins for more than three years are exempt from paying income tax when they sell them; in the United States, profits are not taxed on the sale of the popular American Gold Eagle investment coins (from gold mined exclusively in the USA), UK and EU have no VAT on the investment gold coins and bars, etc.

In general, it can be stated that gold investment coins and bars can hardly serve as a good instrument for a short-term trade, but within the next three to five (and, of course, more) years, this asset can insure the owner against possible disappointments that this current, very overheated stock market can cause.

Apart from gold, what other physical assets can help the retail investors hedge against the current risks? Is it the real estate? It features a too high entry threshold, it is not possible to sell and buy parts of such an asset, the bureaucratic selling and purchasing procedures are rather complicated and slow, and it requires maintenance costs (taxes and payment of utility bills, etc.) ... Isn’t there anything simpler, more mobile? “Well, of course, there is!” the chorus of diamond manufacturers and sellers would exclaim enthusiastically. “Here it is - a wonderful investment asset! Just a retail investor’s dream!” In any case, the official website of the leading Russian manufacturer says with captivating straightforwardness: “Diamonds can be not only a jewellery piece, but also an investment, showing high growth in value in the long term and protecting the savings from currency and country risks.” It is just the thing.

Let’s look at a chart showing the five-year price dynamics for 57-facet round cut diamonds (3 carats, D-J colour and IF-SI2 clarity) that is, for jewellery pieces that are of an investment grade (vertically: IDEX DIAMOND INDEX values).

excl_20122021_1.png

Data: www.idexonline.com

Unfortunately, this chart does not look very impressive compared to the gold price dynamics. We do not see a “high growth in value”. What about the liquidity? Buying a loose certified diamond is not a problem. And what about selling it? Today, dozens of companies can be found on the Internet offering the purchase of diamonds from individuals “at the highest prices corresponding to the current world prices” that are determined on the basis of an examination carried out by highly qualified gemologists. Of course, each diamond is individual and the expertise is possible off-line only. But a preliminary assessment can be obtained by a certificate issued, for example, by the GIA.

As we can see, this poses a problem. In case of selling an investment coin, you can always see the selling price and the purchase price (the bid and asked spread, respectively) on the specialized company’s website, and the prices are linked to the real time stock-exchange quotation of gold. And if your standard UNC (Uncirculated) coin has no visible damages that can be a subject of discussion and discount, the price is known and its pricing mechanism is transparent. In case of selling a diamond, an expert (hence, subjective) assessment is always required, since the only objectively measured characteristic is its weight. Simply put, an investor needs no special qualification when selling investment gold, and it is highly desirable when selling a diamond. Or you will have to spend extra money to pay to the expert whom the investor trusts.

However, as evidenced in practice, the additional costs for an examination are nothing compared to the size of the bid and asked spread set by the companies buying out investment diamonds. The author of these lines has carried out a simple experiment that can be easily repeated by anyone. On the website of a major Russian diamond retailer, an investment grade loose diamond with a GIA certificate was selected. A pdf-copy of this certificate was obtained on the GIA website using the number of the certificate. This certificate was sent to 11 companies buying out diamonds from individuals with a request to give a preliminary price based on the certificate data for the diamond that was (allegedly) offered to these companies by the author. The answers came rather quickly - within 1 to 4 days. The discount was 30% to 70% (!) of the selling price set by the Russian seller (average discount was 49.8%). With a 50% bid and asked spread and almost a zero growth in value within the previous five years, can we talk about the investment attractiveness of the asset? It’s rhetorical.

So, in light of the possible future turbulence on the stock market, a retail investor should remember the words said back by J. P. Morgan in his testimony before the US Congress in 1912: “What is money, gentlemen? Gold is money. Everything else is credit."

Sergey Goryainov, Rough&Polished