06/09/2011 20:03 BST | Updated 06/11/2011 05:12 GMT

Shine on, you Crazy Market

Demand for diamonds is growing for two reasons: firstly, they are one of the most reliable investments during financial disturbances and secondly, the middle class is developing in India and China, which has started buying diamond jewellery. Prices for diamonds will likely keep rising in the next few months.

Meanwhile, from around £875 an ounce at the beginning of this year, gold prices shot up to over £1,190 last week, marking an annual increase of 21 per cent in the price of gold. The average gold price has climbed to £972.5 per troy ounce in July 2011, compared with £327.64 back in July 2006, an increase of nearly 300 per cent. This spectacular rise suggests high demand, not just from investors hedging against inflation and currency crisis, but also some worried central banks like the Bank of Korea and the Reserve Bank of India.

In July, US congressman Ron Paul challenged Fed Chair Ben Bernanke on whether gold is now considered 'a form of currency'. He further asked him why the Fed didn't hold diamonds as an asset instead of gold, if it wasn't really money. Bernanke, who seemed stumped, eventually responded by saying it was a "long term tradition."

He could have said that the price of gold, and diamonds, can be dangerously erratic. We saw the biggest decline in gold since 1980 unfold at the end of August as it fell dramatically to touch the £1,065 mark, with no warning. As I write, it's rocketing back up again as traders bet the Fed will provide further support to the US economy, lifting demand for safe havens such as gold.

Similarly, diamond prices can be hit hard... notably during the credit crisis, but with a bounce back to the upside in 2009 after the leading producers, including De Beers of South Africa, held back supplies to boost prices. Constrained supply, particularly for large, high-value stones, now looks set to continue for the foreseeable future.

Demand rather than supply influences the price of gold. New discoveries make supply erratic. It also gives monopoly power to countries endowed with gold mines.

The world's number one producer of gold in 2010 was China, while Russia is considered the world's largest unexplored gold territory (with many of its sizable deposits having been only recently discovered). It is estimated to have between 25-40% of the world's un-mined gold supply. Russia is currently the sixth largest gold producer in the world and is tenth on the list of the world's largest gold reserves.

Diamonds have emerged as a haven investment to compete with gold and the Swiss franc, with surging demand from Asian buyers driving prices of the precious stones.

Consumption from China and India has helped boost prices nearly 50 per cent since the start of 2010 - mostly in the past six months - and pushed them to historic highs. The value of top-quality polished diamonds of 5 carats has risen to about £93,720 a carat, up from about £62.5-£75k a year ago.

This is being helped along by Asia and its emerging middle classes, who are buying their first diamonds. This is having a huge effect on price, and the share price of companies who deal in them.

Take London-based Gem Diamonds. They have benefitted from a 24.73% increase in the prices paid by Tiffany from April for the fancy yellows it pulls from its Kimberly mine in Australia, while the retailer has increased orders with them by 12%. It announced recently that the first half of 2011 has seen record prices for rough with all segments of carat measurements being in 'high' or 'crazy' demand.

Results released by Tiffany in September showed second quarter net sales rising 30% over the prior year due to strong growth in all geographic regions. Net earnings increased 33% and rose 58% in the quarter, on the previous year. In Asia-Pacific alone, sales increased 55%. They have increased their earnings forecast for the rest of the year to reflect their better-than-expected sales.

Unsurprisingly, the price surges are stoking investor interest. Several groups are putting together funds to give non-specialist investors exposure to diamonds, echoing popular wine and fine-art funds. Yet diamonds have been a disappointing investment over the past decades. Adjusted for inflation, diamond prices are far below their early 1980s peak.

Diamonds - together with gold and investments such as art - yield no annual interest. It also costs money to store and insure the gems. But in a low interest rate environment as central banks try to reactivate the global economy, that is perhaps, ultimately, a small price for us to pay.