If you steal from the mother anemone in the sewers near the end of the dungeon you can get a diamond (the enemy has 3 items to steal so you may need to attempt it multiple times) which can be used to make the strongest weapons. I haven't found an option to make a diamond talisman, but the color of the goddess' talisman looks like a diamond despite it not using any. Maybe later on in the story you can get more diamonds more easily but stealing from the mother anemone gets you a lot of magic clusters, diamonds, and tons of exp since it is always either level 41 or 36 depending on whether you encounter it on the final water tile, or the second to last water tile.
Anyway, the gold knife+2 is actually better than the diamond knife, but the diamond knife surpasses it at +1. The +1 variant took silver and diamonds to upgrade, and the +2 variant takes 5 diamonds and 3 gold to upgrade.