Diamonds Aren’t Forever

Three new minerals-focused funds were launched last week, two of which strike me as interesting, while the third one is fairly perplexing.

Although there’s nothing particularly unique about metals and mining funds, PureFunds ISE Mining Service ETF (NYSE: MSXX) and PureFunds ISE Junior Silver ETF (NYSE: SILJ) take slightly different approaches to the space.

Rather than focusing on the miners themselves, PureFunds ISE Mining Service ETF invests in the companies that manufacture mining equipment, provide drilling or engineering services and perform maintenance or infrastructure build-out.

By concentrating on the services side of the business, the exchange-traded fund (ETF) provides exposure to the growing–yes, growing–demand for all manner of commodities from energy to industrial metals, without the same volatility that accompanies the miners themselves. Even when demand for commodities slackens, miners still have to make necessary expenditures on maintenance and equipment.

The services sector also offers exposure to mining without the competition that can complicate investing in exploration and production (E&P) ventures. Frankly, even with all the new mining regulations and taxes coming into play around the world, from Australia to the US and Brazil, it’s still fairly easy for upstarts to enter the E&P business.

By contrast, the services sector is fairly stable thanks to the major investment needed to build new manufacturing facilities. Additionally, there’s definitely a reputational element involved that favors trusted names.

PureFunds ISE Junior Silver ETF isn’t the first silver mining ETF out there; Global X Silver Miners ETF (NYSE: SIL) and MSCI ACWI Select Silver Miners Investable Market Index (NYSE: SLVP) beat it to the punch. It is, however, the only ETF to focus exclusively on the junior miners in the space.

Given that niche, the fund will likely exhibit significantly more volatility than its two competitors, but it should outpace them when the silver market is strong. And while silver has lost some of its luster since its peak in 2011, it’s still in very high demand.

Both PureFunds ISE Junior Silver ETF and PureFunds ISE Mining Service ETF take a truly global approach to their spaces, offering much more geographic diversity than most similar funds. Canadian companies figure prominently in the silver fund, while Australia has a substantial presence in the mining services offering.

PureFunds ISE Diamond/Gemstone ETF (NYSE: GEMS) is the one fund whose novelty overshadows its investment prospects.

While physical diamonds and gemstones have always been seen as a store of value against troubled fiat currencies, the ETF’s holdings, which include mining outfits, jewelry makers and retailers, are unlikely to serve as a useful hedge in such a scenario. If a fiat currency were to collapse, the equity issues of those companies wouldn’t fare well since miners would have difficulty securing capital, and jewelry makers and retailers would suffer a sharp drop in sales.

Another potential problem is the fact that diamonds and gemstones are the very definition of a manipulated market. Only a fraction of annual diamond and gemstone production actually reaches the market, as major producers such as De Beers hold back most of what they mine in order to keep prices high. If, for whatever reason, it were forced to unload its massive stockpile of stones, prices would plummet pretty quickly.

Beyond that, lab-grown stones are quickly grabbing a large share of the diamond and gemstone market. They’ve become cheaper and easier to produce with the aid of better technology, and they don’t carry the social stigma so often associated with the diamond industry. About the only way you can tell the difference between a lab-grown diamond and a naturally occurring one is the fact that man-made diamonds contain absolutely no impurities. As man-made stones become increasingly popular, naturally occurring diamonds will face more price competition.

All three of the new funds charge annual expense ratios of 0.69 percent, so they’re relatively inexpensive. That said, I’d definitely take a pass on PureFunds ISE Diamond/Gemstone ETF.

Tweet

1. 

   Reply Ami Elstein December 10, 2012 at 8:10 AM EDT

   Another way to invest in diamonds is by owning them outright. The Waldman Diamond Company has created an investor package that simplifies the process of investing in diamonds. For the first time, private investors can now purchase and resell investment grade, GIA-certified, laser inscribed, polished diamonds at wholesale prices through an online Investment Diamond Exchange.