News

Despite the ongoing threat to the economy and to financial markets from COVID-19, and the impact that it is having on our daily lives, opportunities to grow your wealth still exist in the investment world today.

In the coloured diamond space, we are still seeing strong demand for high quality stones, with auctions in Hong Kong this week seeing some coloured diamonds selling at a 30% premium relative to their pre-auction highest estimates.

That is a show of strength, highlighting the fact that investment demand for high quality coloured diamonds remains as strong as ever.

It is our belief that these already strong levels of investment demand will only grow in the years to come, as we explain in detail below.

Why You Need To Diversify

This week we came across another illustration of why investors need to diversify their wealth, and why tangible assets like pink diamonds offer a unique opportunity for wealth protection and growth in the years ahead.

That illustration can be seen in the chart below, which comes from popular Australian finance and investing blog MacroBusiness.

The chart looks at the performance of the Australian dollar vs. the US dollar (pink line), and the performance of the S&P 500 (black line) equity market in the United States from early February to early July 2020.

In the chart, both the currency performance and the stock market index have been rebased to 100 for ease of comparison.

AUD vs SPX index

Source: MacroBusiness

Note how correlated they are.

Whilst equities were plunging during late February and late March, so too was the Australian dollar. If you are an Australian investor and had money in the share market during this period, then it wasn’t just your stock portfolio that got hit.

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It seems that despite all of our hopes, a return to normal in our daily lives and in the economy is some time away, with the spread of COVID-19 accelerating in many parts of the world, including in the United States, the largest economy in the world.

Australia is clearly not immune, with the decision to shut down large parts of Melbourne for the next six weeks, and the closure of the NSW/Victoria border a stark illustration of the challenge we face to manage, let alone control this virus.

The impact on the economy, which was already on its knees, will be severe, with the depth of the recession we are in only likely to worsen in the months to come.

As a sign of the building stresses, consider the following:

• Consumer confidence figures fell to an 8-week low last week, with current readings in line with where they were during the Global Financial Crisis. Households are particularly uncertain regarding when it comes to buying major household items.
• Plans to bring tens of thousands of international students back into Australia are likely to be scrapped, as the public health risk is deemed to be too high. This will impact the education sector, as well as the housing market and hospitality industry.

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It’s been a volatile end to the first half of calendar year 2020, with equity markets correcting in June.

Despite a strong bounce from the late March 2020 lows, investors in shares have seen their wealth go backwards in the first half of the year, with the Australian share market for example ending June almost 13% lower than where it started.

The performance of the market over the last six months can be seen in the chart below. It shows the huge sell off in equities from late February to late March, the recovery from late March to early June, and the weak end to the month just finished.

Source: Google, S&P ASX 200 price chart.

The chart makes it clear that stock market investors went from peak fear to unprecedented euphoria this year, with some signs of nervousness again beginning to creep in.

All up it has been a volatile and largely unrewarding six months for these investors, with markets arguably more fragile today than they were when the year started.

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Financial market volatility has picked up in the last couple of weeks, as investor nervousness about the risks in an extremely overvalued stock market continue to rise.

Meanwhile fears over the continued spread of COVID-19 are also rising, including in Australia, with Victoria having to back-track on plans to ease restrictions for businesses and households.

This is due to a worrying spike in cases occurring over the past few days, with health officials warning of a potential ‘second wave’ of infections.

Indeed, despite our hopes, it appears that COVID-19 cases will continue to rise for the foreseeable future around the globe, which poses a huge challenge to the economic recovery we are all hoping for.

As an example of the ongoing challenge, consider the chart below, which shows the year on year change in restaurant bookings in the United States (via the website OpenTable).

US Restaurant Bookings
YoY Change in OpenTable Seated Diners

Source: OpenTable, Bloomberg.

You can see the huge plunge between late February and March, and the gradual recovery from late April through to May and most of June, as restrictions began to ease.

It’s the drop-off at the end that is the real concern, as it highlights that either:

• Fears (justified or otherwise) over COVID-19 are still keeping people at home.
• People’s financial circumstances are still so dire that they aren’t willing or able to go out and spending money.

Neither is a positive sign, with data points like this highlighting the fact that it will be years before economies in the developed world return to normal.

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Volatility has crept back into financial markets in recent days, with equity market indices like the S&P 500 falling by more than 5% last week.

There are multiple factors which have driven this sell-off, the first of which is that the market had been rising incredibly sharply since late March, with many indices back or near all-time highs, with euphoria replacing despair in barely two months.

This can actually be seen in the graphic below, which was created by Citigroup, and models the level of investor panic or euphoria at any given time, with the chart going back just over one year.

Market Sentiment
Citigroup Panic/Euphoria Model

The panic/euphoria model is a gauge of investor sentiment. It identifies ‘Panic’ and ‘Euphoria’ levels which are statistically driven buy and sell signals for the broader market. Historically, a reading below panic supports a better than 95% likelihood that stock prices will be higher one year later, while Euphoria levels generate a better than 80% probability of stock prices being lower one year later.
Source: Citigroup Investment Research – US Equity Strategy.

As you can see, markets were pretty euphoric right up until COVID-19 hit in earnest in late February. Over the next month, as many equity indices cratered by 30-40% or more, investor sentiment turned to complete panic.

From then on though it’s been party time again, with the investor mood now more euphoric than it was before COVID-19 hit, even though it is crushing the economy in a much more significant way than that which we saw during the GFC (see more below).

The key point for investors is this. According to this model, whenever the market has hit euphoria levels (as it has now) there is a better than 80% chance that stocks will be lower one year later.  

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It’s been another interesting week in financial markets, with equity prices continuing to climb, whilst bond prices are falling. Whilst it’s the former that is getting all the attention, it’s the latter that we think is more interesting, as falling bond prices are a sign that the market might be starting to get worried about higher rates of inflation.

Should higher inflation come to pass in the years ahead, it will be another tailwind supporting higher pink diamond prices, given their scarcity, and ability to hold their value over time.

Last week, we focused on the incredible rise in the Australian dollar, which has climbed above USD $0.70, a near 30% rally in just over 2 months, and why that is a gift for potential pink diamond investors.

In this update, we are going to focus on interest rates and why we now expect them to go below zero in the coming months in Australia. Most importantly, we’ll touch on why this development will further bolster pink diamond investments.

A Story Decades in the Making

Low interest rates are not a new phenomenon, with rates declining around much of the globe since the early 1980s. In Australia, interest rates have been declining since the early 1990s at least, which can be seen in this chart below from the Reserve Bank of Australia (RBA).

Graph of the Cash Rate Target

Source: RBA

From a high of 17.50% in 1990 to their current low of 0.25%, interest rates have fallen 99% in the past 30 years. This has obviously boosted asset prices, but it has also helped fuel a huge private debt bubble that has led Australian households to become the second most indebted (relative to economic output) in the Western world.

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The Australian economy is reopening, with restrictions on commerce slowly being lifted in most states. The spread of COVID-19 looks to have largely been contained for now, which is good news for all of us, from a lifestyle, health and economic perspective.

For pink diamond investors, one of the most interesting developments in financial markets since panic selling reached a crescendo in late March has been the surge in the value of the Australian dollar (AUD).

In the last two and a bit months, the AUD has risen from a low of roughly USD $0.56 all the way back to USD $0.69, an increase of 25%, with the AUD now essentially unchanged for the year.

There have been multiple drivers of this rally, including a rally in the price of iron-ore, and optimism that the global economy will experience a V shaped economic recovery from the COVID-19 imposed lockdown.

General weakness in the USD against a basket of currencies has also been a contributing factor.

Given pink diamonds are priced in US dollars, this increase in the value of the Australian dollar is important. This is because it effectively means an Australian pink diamond investor can get a lot more bang for their buck today, in terms of the diamonds they are purchasing compared to just over two months ago.

In this article we give an example of how powerful these currency movements can be. But first we explain why we think this AUD rally won’t last, and why pink diamond investors should take advantage of it now.

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Things continue to improve in the battle against COVID-19, with Australia slowly reopening. This is unquestionably good news, even if the path forward in terms of managing the ongoing health risks remains unclear.

Investors will also have many challenges to deal with in the coming years, one of which is likely to be higher inflation. Over the last two decades, official inflation rates have trended down, with many investors now convinced we won’t ever see it return, and that it’s no longer a risk to manage in their own portfolio.

We don’t agree.

Perhaps more than anything else, the chart below highlights why we think higher inflation is on the way, and why it is now a bigger threat than at any time in the last decade.

The chart shows the balance sheet of the United States Federal Reserve (The Fed), which recently topped USD $7 trillion, and how it has grown over the last 15 years. Note that when The Fed wants to grow its balance sheet, it literally just enters keystrokes on a computer to add zeros to its own accounts. Neat trick!

Source: Board of Governors of the Federal Reserve System (US).

Note that the grey shaded area in the chart represents the Global Financial Crisis (GFC), which was when the original sharp jump higher in the balance sheet took place. This was as the result of The Fed printing money to stave off the worst of the housing market collapse which precipitated that crisis, as well as support broader financial markets.

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Like many Australians, we enjoyed our first weekend of relative freedom, enjoying a trip to the shops, a coffee at our local coffee shop, and a trip to the park with our children.

The streets and the shops were incredibly busy, a good sign that things continue to head in the right direction, though we think it will be years before we return to normal, with millions of Australians likely to remain reliant on the government for economic ‘life support’ for the foreseeable future.

Economic data suggests we have a hard slog ahead of us, with last week’s unemployment figures in Australia suggesting the unemployment rate would have headed toward 10% were it not for the huge reduction of Australians in the labour force.

The problem is clearly global in nature, with the St. Louis Federal Reserve GDP Nowcast model (essentially a forecast for the current quarter’s economic output) forecasting a 48% decline in US economic activity.

Stock markets are still by and large ignoring the economic reality, though we think the next few weeks may well see downside risks re-emerge.

In this week’s market update we look at how kind financial markets have been over the last several decades, why history won’t repeat, and why now is the time to invest differently.

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Earlier this week we shared a fantastic article in the South China Morning Post (accessible here) which looked at the pending closure of the Argyle Diamond Mine and discussed the implications for prices in the years ahead.

In this report we wanted to share some specific sections of that article, starting with the following extract, which is sourced directly from it.

The article touches on several themes that will be familiar to clients of Australian Diamond Portfolio, notably the fact that the Argyle Diamond Mine is scheduled to close in 2020, and once it does, there will be a roughly 90% reduction in the number of new coloured diamonds that will come to the market each year.

Astute investors are already buying in anticipation of the price gains this will likely lead to in years to come. Diamond insider, Harsh Maheshwari of Kunming Diamonds, was quoted in the article, where he noted that since the second half of 2019, a number of jewellers have reported a level of requests for Argyle pink diamonds that they had not seen previously.

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