When it comes to diamonds, the real money is made in the diamond mines, but don't get your shovel out just yet. Check the share prices of companies like Anglo American Corporation or Rio Tinto, because precious metals can turn out to be precious investments.

For the better part of a century, De Beers (the world's largest diamond miner) controlled the flow of diamonds into the market, aiming to avoid the price peaks and slumps of unmanaged supply. This approach, however, led to De Beers establishing a cartel that controlled the world's diamond supply, thus contravening US law.

So when the mining companies Rio Tinto and BHP Billiton established their own marketing channels, De Beers decided to move away from trying to manage stocks and prices to become "the supplier of first choice, rather than the buyer of last resort". Three years ago, De Beers was taken private by a consortium bid that included listed mining company Anglo American Corporation, and in July 2004 it also plead guilty to fixing industrial diamond prices in the US, so it can now deal there directly instead of using intermediaries.

The questions investors need to ask are, where will companies look, and will they find what they are looking for? Suitable geological structures, known as kimberlites, are spread around the globe, but De Beers estimates that only one in 200 kimberlite pipes contains diamonds in economically viable quantities.

The value of a diamond
Diamonds are not a commodity, they are highly differentiated products. Industrial-grade diamonds are small and of low-quality, so they are used in things like cutting tools. Diamonds near to gem grade, on the other hand, are used in clusters for highly affordable jewellery, of which Wal Mart, the giant US chain store, is a major retailer, while gem-grade diamonds are of the type that we normally think of as being used for jewellery, such as engagement rings.

Aside from carat, the other features that have an impact on diamond pricing are clarity, colour and cut. Clarity is the most important, as it refers to the imperfections or inclusions. Colour, and in particular the consistency of colour, also makes a difference. The cut, meanwhile, comes after the mining stage but is critical for diamonds to show their characteristic sparkle.

THIS ARTICLE IS REPRODUCED COURTESY OF SMART INVESTOR MAGAZINE