GEMS: A Better Hard Asset ETF?

After a rough patch in the first half of 2013, natural resources finally took off with the Fed deciding to postpone cuts to its stimulus program. Although the Fed may still taper soon, it is not yet final, so commodities may still have some room to run in this weak dollar environment.

This bodes well for commodity mining ETFs that depend on the price changes of their underlying assets. A good example of this is the precious metal and gemstone market, where asset demand has surged amid geopolitical concerns and worries over a government shutdown back in the U.S. (read: 3 Mining ETFs Finally on the Upswing).

The improving China data is also playing a major role in driving commodity mining ETFs. Investors were naturally encouraged to pick precious commodities on hopes of higher returns. Leveraging the trend, SPDR S&P Metals & Mining ETF (XME), which was down about significantly to start the year, has really turned it around in the past few trading days, beating out the overall market.

In such a situation, investors seeking to tap a new form of hard assets can consider the overlooked option of diamonds. Along with gold and silver, diamonds are also compelling opportunities, and can benefit from the broader metal strength.

The return from The Diamond/Gemstone ETF (GEMS) from upstart PureFunds in the last one month breezed past commodity ETFs like GLD, while it also beat out larger mining products like XME as well. Given this solid performance, some might be wondering what lies beneath this uptrend and whether it will continue.

Demand Outshines Supply

The demand-supply scenario is favorable for diamonds with global demand expected to increase 5.9% annually through 2020, but production likely to expand only about 2.7% annually over the same time period, as per market research firm Bain & Company.

Demand is trending higher especially in Asia, both in terms of jewelry and investment with India and China accounting for major chunks of global demand. Both markets are still in their nascent stages, indicating a wide runway for future growth (also read A Complete Guide to Mining ETFs).

Specifically, demand from India has recently seen a surge on increased import taxes on gold to cut dollar expenditure, which has hurt the yellow metal’s appeal in comparison to other metals. Moreover, imports of rough diamonds, which comprise almost 90% of all diamonds brought into India, do not attract any levy. Polished diamonds, however, charge a 2% import tax.

According to Bain & Company, the diamond industry was largely unscathed during global downturn, probably as this precious stone is purchased by high-end customers who were somewhat immune to recession. Moreover, the firm expects several new mines to come online by 2020.

Geopolitical concerns and their influence on other regions have also infused some fresh blood into diamond investing. All this has set a bullish tone for investing in the Diamond Mining ETF which should see a pickup on the higher demand for precious stones.

Diamond ETF in Focus

PureFunds ISE Diamond/Gemstone ETF (GEMS) tracks the gemstone industry including exploration, production or sales of precious stones. This is done by following the ISE Diamond/Gemstone Index, a benchmark that holds about 24 holdings in total.

In terms of a national breakdown, the U.K. takes the top spot at 34%, followed by the Hong Kong (27%), Canada (20%) and the U.S. (10%). Japan and Israel account for single-digit allocation.
The product is also somewhat concentrated in its top holdings with Chow Tai Fook Jewelry taking the top spot with 8.9% of assets, followed by Anglo American and Petra Diamonds both of which account for more than 7.5% of assets.

However, the fund has an inclination towards small-caps with more than 60% of the allocation. While this might lead to a certain amount of volatility, greater exposure to blend style (more than 80%) provides some cushion to the volatility.

Most of the companies in this fund focus on the jewelry industry as well as broad miners that deal within the gemstone space (also read IndexIQ Files for Industry First Diamond ETF). However, the product is a bit pricey in the commodity producers equity space charging 69 bps in year.

Bottom Line

Despite the solid performance for GEMS and its unique exposure profile, the fund remains unloved by investors. Volume and assets under management are both very light, so make sure to use limit orders if you are thinking about this product.

Still, if you are able to get by the low volume, GEMS could offer up an interesting choice in the mining/hard asset space. Diamonds and gemstones are overlooked by many other ETF products, and given the solid performance of the space lately, this could be one segment that may be worth a closer look heading into the end of the year.

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