The Recessionary Economics of Gemstones

by Lapigems Gem Company 16. November 2010 05:39
A cursory look at the economics of precious stones, with particular regard to inflationary economic environments

There are not many people who would argue that the present economic situation and outlook for the future seems very confusing. On the one hand, there are proponents of the view that economic recovery is well underway and the good times are just around the corner. On the other, there are an equal number who subscribe to the more pessimistic view that a “double-dip” recession is inevitable and that inflation and hyperinflation are looming on the horizon. Certainly, the speed with which many of the developed world’s central banks are printing money does give pause for thought. We had the much vaunted Quantitative Easing program which dumped billions into banks round the world and now QE2 looks set to launch too. There seems to be a very concerted push to force money through the system by whatever means necessary.

Now, depending on which school of economic theory you come from, the general rule of thumb is that a massive increase in supply, without a corresponding increase in demand, causes value to drop. Hence, in the case of money, the value of money drops when banks print money in this fashion. The textbook case is, of course, Zimbabwe, where the policies of Robert Mugabe caused the most severe case of hyperinflation on record. The Zimbabwe Central Bank printed a One Hundred Trillion Zimbabwe Dollar note by the time it effectively scrapped its currency in April 2009 and allowed foreign currencies to be used instead. This is all fairly logical as "easy money" should lead to inflation. However, in the case of the US economy, the broadest measure of money, M3, is declining at a rate not seen since the Great Depression. There is no money velocity (speed with which money moves through the economy) and deflation appears to be a more looming threat than inflation at present. Indeed, this is reflected in the fact that Consumer Price Indexes are declining, not increasing. This is the basis behind a new round of Quantitative Easing – a further attempt to increase money velocity by pushing money out of the banks and through the economy.

Why is Gold Outperfoming Most Asset Classes?

However, if we are in a deflationary environment, why is gold outperforming most assets? Gold prices are headed for record highs. Traditionally, gold values increase with inflation. The last great run up in gold occurred during the inflationary 1970's, when stagflation in the USA caused massive inflation. Mortgage rates headed for the 20% mark and even gasoline was scarce. This does not seem to have any resemblance to the economic situation today. During that period, there was a direct correlation between precious metals and diamond and colored gemstone prices. As gold increased, so did tangible assets. The answer to this anomaly could be that gold is also regarded as a “safe haven” or crisis hedge. In times of uncertainty and/or national crisis, people fear that their assets may be seized and that the currency may become worthless. They see gold as a solid asset which will always buy food or transportation. Thus, in times of great uncertainty, the demand for gold rises. The stock markets function upon confidence and when confidence disappears, markets collapse. Recent crashes like the one on 6th May 2010 where the Dow crashed over 900 points in a matter of hours create a feeling of instability and people lose confidence in the system. This, coupled with declining real estate markets, has influenced many to invest a small portion of their wealth in something portable, private and rare.

Gemstones as a Tangible Asset Class

Certainly, gold has been a huge beneficiary of the current sentiment, however a certain smaller percentage of people are also buying gemstones as a hedge. Collecting fine gems is a relatively new phenomenon in the USA. However, throughout history, examples abound of instances where gems have saved people in times of political and economic crises. Some notable examples are Nazi Germany, Vietnam, Iran, and Hong Kong and even when Imperialist Russia collapsed, gemstones carried by escaping imperialists enabled them to start a new life in other countries. Political instability, high taxation and currency devaluation, have meant that may people in parts of Asia, South America and even Europe, have long been aware of the significant role that gemstones play in conserving capital. Fine quality diamonds and colored stones have long shown themselves to be excellent long-term hedges against economic uncertainty and currency depreciation. Rare, fine gemstones represent an excellent and highly portable repository of value. Certainly, this concept seems to be bearing itself out in the market - international collectors and investors have pushed colored diamonds and colored gemstones to record highs during this economic climate at each major auction. In view of the state of affairs and uncertainty of our times, it seems wise to research other areas in which to invest capital. Most financial advisors will suggest that a percentage of one’s portfolio be in hard assets, you could do worse than consider colored gemstones.  

Lapigems Gem Company

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