Soybeans, Pork Bellies, and Diamonds: the Power of Financialization

For as long as most of us remember, commodities as diverse as crude oil, gold and soybeans have been traded as financial assets. Forty-seven commodities, including frozen concentrated orange juice and recycled steel, currently trade on 12 global exchanges. While trading these materials dates to the dawn of civilization, the financialization of commodities, enabling their trade as financial products, is a recent development.

Agricultural products and precious metals were actively traded and bartered in ancient civilizations. It’s only within the last century that the creation of standardized units and electronic trading platforms has transformed dealer-driven markets dominated by producers into asset classes available to investors.

Crude oil is a good example of this progression, having evolved into a financial product in New York on March 30, 1983. Prior to that, crude contracts had been traded for physical delivery among industry participants almost since the discovery of oil in 1859.

It took 100 years for crude to become a financial asset that would be traded by investors more than producers and their customers. During a time of stable production and consumption, the launch of crude futures caused trading volumes to explode despite the existence of multiple sources and grades.

The soybean market experienced similar development using unique designations to facilitate efficient trading of different soybean grades like standard grade, mixture, GMO, No. 2 yellow, non-screened and stored in silo. There are even distinctions by state of origin, such as Iowa, Illinois and Wisconsin. Specifications also apply to contracts on cotton, orange juice, cocoa, sugar, wheat, corn, barley, pork bellies, milk, feed, fruits, vegetables, livestock, meats and poultry. Investors and industry participants accept these standards which enable trading and liquidity.

Bond trading followed a similar path, having been traded by a close-knit group of dealers that predominantly traded between themselves over-the-counter using direct telephone calls.

In 1972, Cantor Fitzgerald bought a 25% stake in the financial data firm Telerate, then a pioneer in the electronic distribution of real-time market information. Telerate, and subsequently Cantor Fitzgerald, used then-emerging computer and communications technology to create price transparency in what had been the classic “Wall Street Boys’ Club.” Over time, the marketplace grew, volumes increased and price transparency improved for everyone.

As primary bond dealers lost control of the market, efficiency increased, spreads declined and the importance of liquidity superseded control. Dealers remained influential in helping to drive the market, which ultimately grew so large that no single dealer could dominate pricing, execution or liquidity. In today’s world, the bond market is highly liquid, with multiple electronic platforms, enabling seamless trading of more than 15,000 different bonds daily.

But what about diamonds? Why has a transparent and efficient financial market for diamond trading never taken off? As with bonds prior to 1972, diamond trading has historically been a dealer-driven market where prices are privately negotiated between miners, manufacturers, dealers and retailers in a secret and complex system.

Mostly driven by the themes of luxury and love, diamonds have been an accepted store of wealth for centuries. However, the marketplace for trading them suffers the same limitations experienced by other dealer-driven markets before they evolved. Even though no two diamonds are exactly alike, they are in fact no different than other commodities when carefully graded and “pooled” to facilitate physical or futures trading with complete price discovery and transparency.

History repeats itself, and technology is once again enabling the evolution of an industry and the financialization of a tangible asset. VULT technologies pools diamonds into tradeable units of equal value for physical delivery or ownership by certificate.

VULT sources Gemological Institute of America (GIA) graded diamonds from primary diamond manufacturers globally, eliminating the inefficiencies of intermediate dealers. Diamonds are visually inspected and laser measured to insure all collection grade standards are met, not just the four C’s commonly referenced by dealers and retailers.

High security protects the diamonds enclosed in each VULT, enabled with advanced metal-free ceramics and single crystal sapphire, as well as patented state-of-the-art optical identification technologies. VULT provides for easy and secure authentication using a freely downloadable smartphone app.

For the first time in history, diamonds can now be traded just like other asset-based financial instruments.

And while it might take a few years to fully develop into a highly liquid market like that of other commodities and financial assets, increasing government invasiveness and global economic uncertainty will accelerate this development. As in the past, early investors will be rewarded as diamonds follow the same path to financialization taken by other commodities.

The financial diamond marketplace will grow and volumes will increase as VULT becomes the catalyst in developing a major new opportunity for investors and diamonds join the list of highly liquid assets investors can profit from.

– Jay Plourde

Originally published as “A Gem of an Opportunity” in The Bauman Letter, May 2017.