Tales of Soft Money — The Forever Stones — Part III


Russians and the Infinite Inflation Bug?

As has been described in previous articles, the Soviet Union had since earlier a contract to exclusively supply De Beers with their Siberian diamonds in exchange for money and good industrial-grade counterparts. This equation changed in the 70's, and it started with an ever growing supply of uncut stones reaching the De Beers London facilities. Upon inquiring how the Soviets managed to have such an incredible output from just a few 'pipes', the Soviet representatives first argued that the carat content in their ore was extremely high - in fact higher than any pipe mine in the history of diamond mining. Furthermore, the Siberian pipes seemed to, opposite to how they naturally ought to work, produce more diamonds the deeper men and machines dug. As De Beers geologists could not make sense of it all, they invited themselves for a visit to the mines in exchange for Soviet diamond experts being allowed access to some of the African mines.

After landing in Moscow, the De Beers people lead by Sir Philip Oppenheimer were purposefully delayed there, and evening after evening they were sent to the best restaurants that the city could offer. Insisting that they had a job to do they were finally allowed by the Soviet Diamond Administration to board a plane to Yakutia. Chief geologist Hawthorne, accompanying the delegation, noted with awe that the Russians dug for diamonds without using water in the separation steps. You may recall that in the De Beers Orapa mine, centrifugal baths were utilized in order to separate the 1% heavy material of the crushed ore, from the 99% useless waste. Only the high-density content was then sent for extensive X-raying. The Soviets on the other hand, due to operating in a climate where water often froze solid, X-rayed the crushed ore itself, which had Hawthorne incredibly skeptical. For that to work, the geologist argued, thousands of specialized Sortex machines and millions of volts of electricity would have had to be used. Hawthorne told Epstein that he had seen no physical evidence of such Sortex machines, nor of extensive power lines.

Furthermore, the visited Siberian mine itself was smaller and also far less deep than the De Beers geologists had calculated, indicating further discrepancies between the output regularly sent to London in Aeroflot airplanes, and the actual production site. The more Oppenheimer and his colleagues saw, the more they suspected that something was not right. And maybe not surprisingly, reports started pouring in to the headquarter about advances in Soviet high-pressure technology. Even a decade earlier, anecdotal evidence from Westerners attending Soviet diamond conferences made it clear that the Soviets were able to produce large synthetic industrial-grade diamonds. Epstein also mentions one 1966 conference in Moscow where two British mineralogists were shown white gem-quality synthetic diamonds weighing a quarter of a carat each. The Russian scientist supposedly boasted that for the Soviet Union, the synthetic production of gem-quality diamonds was no longer a scientific problem, but an economic one.

Professor Bakul, director of the Soviet Synthetic Research Institute, had just recently recruited Joseph Bonroy, one of the best diamond cutters in Antwerp. Supplying the Belgian with stones of excellent purity, Bakul had to reveal the secret of their source himself since the only strange aspect of them that Bonroy noted was the very unorthodox sawing directions needed to cut them. After finding the proper solution to cutting the synthesized gems, Bonroy judged that they looked exactly like ordinary gem diamonds.

Even more confusion ensued as the Soviets started cutting a small percentage of their diamonds themselves. Lois Asscher, one of the most renowned cutters in Europe and the inventor of the Asscher cut (the 'brilliant cut' of a triangular diamond), acquired such stones and studied them intently. After some effort, he managed to find one type of mark present on all of them - the bearings of a machine. He concluded that the Soviets must have invented an automatic diamond cutting machine, but some of his colleagues disagreed; the diamonds were to good, too regular, too perfect to be anything but they work of skilled human hands. Few knew what to make of it all; what was clear was the ever increasing supply pressure of expertly cut sub-carat diamonds stemming from the Soviet Union.

De Beers could not strictly prove that the Soviets diluted their shipments with synthesized diamonds, and since it was still expensive to produce such stones, they managed to deal with the situation by restricting output from their own African mines in the 70's, while buying up the increased Soviet exports. I don't want to speculate to much on the matter - the fact is that the confusion instead underlined the core problem itself. As the synthetic diamond production technology improves with an ever increasing speed, while the produced stones themselves have identical chemical structure, hardness, optics etc as their mined counterparts, one might already extrapolate the future outcome of this arms race.

De Beers Today

Epstein himself does not clearly spell out his conclusions from the above anecdotes. As his recount of the investigation runs out of ink, it anyway leaves us with a rather good understanding of how De Beers emerged in the 80's. The company still controlled a vast monopoly on natural diamonds, and the world's experimentation with synthetic gem-quality diamonds had just started whereas the synthetic industrial-grade diamond production was since long an established industry.

With the fall of the Soviet Union, Russia finally let its diamond contracts with De Beers run out, meaning its state diamond company Alrosa could start supplying its rough stones to any diamond cutter that would take them. And with the discovery of the Argyle mine in western Australia in the 80's, and new Canadian mines in the 90's, those countries' diamond production fell outside the reach of De Beers as well. In the year 2000 it may be argued that the the century-long cartel had finally collapsed due to the nature of the new global supply. It is estimated that the company at time of writing produces between 35-45% of the world's uncut diamonds, and it still has a strong presence in South Africa and Botswana. But as more normal market conditions were allowed to affect prices, we have seen mostly side-way or declining movements since, with the exception of the 2011 commodity bubble.

After initially putting on a brave face against the threat of synthetic gems, De Beers has just recently entered the lab-grown gem market themselves. This should be viewed in the light of a July 2018 US Federal Trade Commission amendment of its Jewelry Guides, clarifying "a diamond is a diamond" regardless of its origin. From having their researchers focus on, among other things, tools for oil and gas drillers, lasers and speaker systems, the same De Beers researchers are now producing gem diamonds in the English countryside via the Element Six Innovation Center. Launching a line of fashion under the name of Lightbox in 2018, De Beers was partially accused by the industry of 'dancing at two weddings at the same time'. It remains to be seen how the introduction of synthetic but incredibly beautiful diamond jewelry will influence the traditional market of natural diamonds.

De Beers' decision caused an even wider gap between the price of synthetic and natural diamonds. According to analyst Paul Zimnisky, a generic synthetic 1-carat diamond was around 40% cheaper than its natural counterpart in the end of 2018. Other diamond consultants point to the fact that the costs of producing a 1-carat synthetic diamond have plummeted more than 80% in only a decade, to around USD 800 per carat. Bain & Company's latest annual diamond report goes even further and mentions a cost of as little as USD 300 per carat for a CVD lab-grown diamond, down from USD 4 000 a decade ago. The cost dynamics, in other words, are such that while natural diamonds get ever harder and so more costly to dig up, gem-quality synthetic diamonds get ever easier to produce.

The Synthetic Diamond Arms Race

Established in 1931, GIA is the leading diamond institution to safeguard the authenticity and quality of such gem stones. The organization established the 4CS-approach in the 40's, where a diamond's cut, clarity, color and carat weight are all graded. Naturally, it also helps diamond dealers in establishing whether a gem is synthetic or natural. This last part is tricky and demands highly trained and experienced personnel as well as sophisticated machines. GIA mentions two different methods of which synthetic gem-quality diamonds are made:

Today, laboratory-grown diamonds are created by two methods, according to Dr. James Shigley, GIA Distinguished Research Fellow, who has been researching laboratory-grown diamonds at GIA for more than 30 years.

High pressure, high temperature (HPHT) diamonds are produced in a laboratory by mimicking the high pressure, high temperature conditions that form natural diamonds in the Earth. This process produces a distinctively shaped laboratory-grown diamond crystal.

The chemical vapor deposition (CVD) method involves breaking down the molecules of a carbon-rich gas, such as methane, into carbon and hydrogen atoms, which then are deposited on diamond seeds to produce a square-shaped, tabular diamond crystal.

Anyone reading between the lines of GIA's conclusion with regards to the two methods, should understand that the diamond market may be in trouble:

GIA Senior Research Scientist Dr. Sally Eaton-Magaña further explained, "The identification criteria for HPHT and CVD diamonds are quite distinct from each other," adding that laboratory-grown diamonds have become much more varied over the last 10 to 15 years, requiring GIA researchers to keep pace with new developments.

As the diamond monopoly now is broken and more or less anyone can supply diamond-cutters with rough stones, it becomes evident that it is in the economic interest of many to produce synthetic or enhanced diamonds that are harder or even impossible to distinguish from natural diamonds. This may be achieved through a to this day unknown method, or simply by modifying one of the existing ones. By semi-randomly applying various contaminants to the HPHT-method, for example, it may very well create synthetic rough diamonds with enough impurities to trick GIA and other grading experts.

Another creative exploitation could be the post-mining processing of low-grade stones. There are today already a number of heat treatments available to get more out of natural stones - one example being the production of the rich blue tanzanite. It is not far fetched to assume low-grade diamonds in the near future could have applied to them some type of high temperature, high pressure post-mining procedure that has it come out enhanced in one way or another. As diamonds today changes hand many times before reaching retailers, such 'infusions' could enter this chain at any point, from the mine itself, to the cutting facilities. All in all, the attack vectors seem endless. Joel Arem, Ph.D. in Mineralogy from Harvard University, has the following to say:

The combination of treatment, duplication, and imitation has changed the very nature of the gem and jewelry industry. "Natural origin" can no longer be assumed. The production of crystals is a global enterprise, and so laboratories and factories around the world (as well as mines) have to be considered as potential sources for materials that are sold within the gemstone industry. The number and type of such materials are astonishing. Equally amazing (and disturbing) is the number and variety of methods that can be used to change the appearance of both natural and synthetic materials. Heat is still part of the menu. But now the gemstone treatment kitchen uses irradiation, diffusion, and many other techniques to expand the palette of objects that are eventually set in metal and sold in jewelry stores. New methods and materials are coming into the marketplace all the time, and the jewelry industry, mired in tradition and slow to change, simply cannot keep up.

The whole situation is akin to a looming 'infinite inflation bug' that is costly but not exceedingly so, to execute. This inherent execution cost is diminishing at a rapid pace, as is evident in the spread between paying to create a CVD diamond, and paying to dig for a natural diamond. This spread reflects the free resources available for counterfeiters to come up with an exploit of the 'infinite inflation bug'. Joel Arem continues:

Detection of CVD, HPHT, and other synthetic diamonds, one of the biggest challenges to the gemological world, relies on measuring a variety of properties, few of which individually can be used to make a definitive ruling. Moreover, the required equipment is typically complex and expensive and far beyond the reach of jewelry stones and small laboratories. Realistically, unambiguous certification of a diamond as natural versus synthetic can only be properly done by major testing laboratories. The cost of analysis is high enough to prevent all but a relative handful of polished diamonds to be examined. This means that perhaps 99.999% of ALL polished diamonds will never be certified. Bulk screening has been offered as a potential solution, but some screening methods only identify gems that might not be natural and therefore will require further testing. Newer technologies are being developed that might offer somewhat more reliable confirmation. The major issue is not "can you identify" a manufactured diamond. The issue is "will you do the proper testing." This is a function of cost, which may turn out to be prohibitive for all but larger and more expensive stones. The disparity offers to unscrupulous traders the opportunity and incentive to add synthetic polished diamonds to parcels of natural stones, relying on their identical appearance and properties to avoid detection. It is possible that, in the future, many small diamonds will be sold with no guarantee that they originated in a mine and not a laboratory or factory.

Monetary Premium

BAUNAT, an Antwerp-based diamond dealer, explicitly states on their webpage that customers should blindly trust the High Council for Diamonds (HRD), the Gemological Institute of America (GIA) and the International Gemological Institute (IGI) when it comes to the provenance of diamonds. And what else are they supposed to say in the face of this new reality? Running a 'diamond full node' verification check for each and every diamond is far too expensive for most, and so customers indeed have to trust the supply lines and to some degree the various institutions of the sector. BAUNAT, as an example, does not provide diamond certificates for stones smaller than 0.3 carat. The fall of the monopoly, combined with the highly probable slow dilution by natural-looking synthetic diamonds will likely result in enough extra supply to hurt the monetary premium of diamonds as an asset.

Various data sources point to a uncut diamond stock-to-flow ratio of around 8, with approximately 150 million carats produced per year in relation to total worldwide reserves of around 1.2 billion carats. A transportable, durable asset with a stock-to-flow of 8 will clearly have some monetary premium, and one of the main indications of this is the fact that uncut gem-quality diamonds today are no longer used for industrial purposes, as lab-grown stones are employed more cheaply but with the same good result. Yet the uncut natural diamonds still fetches a very high market price, and often end up as jewelry. People, in other words, value diamonds not mainly because of their utility or how they look (cheaper and more abundant substitutes have been proven to 'capture' glimmering light more effectively) but because they are perceived as relatively scarce. The fact that re-selling a diamond is an expensive and probably rather disappointing experience has not really affected the monetary premium in the first place.