Recording of "Black Diamond Bay" commenced on July 29, 1975, with twelve takes being recorded. These initial takes utilized an expanded list of instrumentation including mandolin and trumpet.[1] The next day saw five more takes performed with a stripped-down lineup, resulting in the final version selected for the album.[1]
The song's lyrics depict a list of characters including a woman with a Panama hat, a suicidal Greek man, a soldier, and an unsuccessful gambler, all located on the titular island during an oncoming natural disaster.[2] As the characters partake in their exploits, a volcano on the island eventually erupts, resulting in their deaths and the destruction of the island.[1] The final verse of the song reveals the narrator to be an outside observer, having only learned about the disaster from a news broadcast.[2] The work of author Joseph Conrad was a mutual inspiration for both Dylan and Levy;[1] some[2][3] have singled out Conrad's novel Victory (1915) in particular as an influence on the track.