PureFunds’ diamond ETF looks ready to sparkle

Jan 18th, 2013 | By | Category: Commodities

Following an overshoot in prices in 2011, the rough diamond market corrected in 2012 and prices have returned to equilibrium. Except for a positive scenario that provides a better-than-expected global recovery, rough diamond prices are forecast to remain relatively stable in 2013 and 2014. However, following last year’s price correction, there is now limited downside in diamond-related equities and plenty of reasons to be bullish, most notably increasing Asia demand. That’s the view of Nomura, the investment bank, which recently initiated on the diamond sector with a report entitled, ‘A long-term story that is ready to sparkle’.

PureFunds’ diamond ETF looks ready to sparkle

The PureFunds ISE Diamond/Gemstone ETF is well placed to benefit from improving diamond supply/demand fundamentals.

Since the launch of the PureFunds ISE Diamond/Gemstone ETF (GEMS) on the NYSE Arca in November last year, investors can access this sector in pure-play form in one simple trade.

The fund, which is dedicated to global companies that are actively engaged in the gemstone industry, allows investors to gain immediate exposure to the supply/demand fundamentals of the rough and polished precious stone industry – fundamentals which look increasingly positive.

In the past few years there has been minimal significant new diamond exploration. This, coupled with increasing demand, has created a very favourable longer-term supply/demand dynamic for miners, with demand expected to outstrip supply from 2015 onwards. In turn, this should lead to enhanced margins for the already robust producers and likely start a new diamond exploration cycle.

Demand is being powered by Asia where an expanding middle class is supportive of a long-term bull market. Based on current nominal growth estimates, Asian nominal incomes are forecast to double between 2010 and 2017. The potential increase in disposable nominal income, especially in China with efforts to rebalance the economy, should see a new group of consumers emerge.

China appears to be moving towards western consumption levels

China appears to be moving towards Western consumption levels (© Nomura)

In China, consumption appears to be moving towards Western levels. Currently, only 30% of Chinese jewellery contains diamonds, relative to 50% in the US and Japan collectively.

Similarly, diamond engagement rings in China remain a rarity. As such, with rising personal incomes, the Chinese market could become a significant source of growth (see chart).

There’s another key reason to be interested in diamonds and gemstones. According to the World Gold Council and Anglo American (owner of De Beers, the world’s largest diamond company), investors account for 44% of gold demand, but they account for less than 1% of diamond demand. This highlights the potential for new investment demand to impact the gemstone market, particularly as investors continue to worry about the inflationary effects of loose monetary polices and increasingly seek the sanctuary of real, hard assets.

Nomura’s favoured stocks in the sector are Petra Diamonds, which offers a long-term growth story, and Harry Winston (soon to be Dominion Diamond Corporation), which has a strong balance sheet and attractive geopolitical exposure.  Importantly, both these stocks feature among the top-five holdings in the PureFunds ISE Diamond/Gemstone ETF, with a combined weight of 15.25%. The remainder of the top five is rounded out by Anglo American (6.99%) and two major retails, Signet Jewelers (7.32%) and Chow Tai Fook Jewellery (7.22%).  Of these, Chow Tai Fook is particularly appealing owing to its 1000 plus stores in mainland China.

The PureFunds ETF is benchmarked to the ISE Diamond/Gemstone Index. To be eligible for inclusion in this index, a number of criteria must be met, the primary one of which is that only listed companies with a market capitalisation of at least $50 million who are actively engaged in some aspect of the gemstone industry are included. Weightings are apportioned based on a formula that takes into account market capitalisation and relevance (i.e. percentage of sales generated from the gemstone industry). Certain other caveats, such as weightings caps, ensure that the index is diversified and tradable. The index is currently comprised of 24 securities and has gained 4.62% so far this year with annualised volatility of 14.10%.

The fund has an annual expense ratio of 0.69%.

(The PureFunds ISE Diamond/Gemstone ETF [GEMS] is aimed at US investors, but while this doesn’t preclude UK, European or other foreign nationals from investing, overseas investors should consider potential tax implications, which can be less favourable.)

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