News

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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Yesterday, South China Morning Post published an article on pink diamonds, with particular focus on the scheduled closure of the Argyle mine, it’s impact on global pink diamond supply and how this is likely to drive up prices in the years ahead.

We hope you enjoy the article and look forward to any questions or comments you may have.

The original article can be found here.

Are Argyle pink diamonds about to shoot up in value? As zero supply looms, what’s next for the luxury jewellery market?

The price of rare pink diamonds is expected to skyrocket as the world’s primary source – Rio Tinto’s Argyle mine in Western Australia – goes offline, so does that mean prices will increase tenfold?

Gaynor Thomas
Published: 12:00pm, 11 May, 2020

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It’s been another positive week for Australia in the fight against coronavirus, with more restrictions on businesses and social movements being eased, sporting codes preparing to recommence their seasons, and even talk about a resumption of international travel between Australia and New Zealand.

Despite this, financial markets have begun the month on a volatile note, with the ASX recording a 5% fall on Friday 1st May. After such a big rally in April (the ASX was up almost 10% for the month), a pullback of this nature was to be expected, with many respected commentators stating that they think equity markets will re-test the lows seen in late March in the months ahead.

This would make sense to us, as whilst things do look like they are getting better in the fight against coronavirus, they’re almost certainly getting worse in the economy.  The latest data from the Australian Bureau of Statistics (seen in the chart below) suggests the number of jobs, and total wages paid in Australia dropped by 7.5% and 8.2% respectively in the month to mid-April.

Changes in employee jobs and total wages indexed to the week ending 14 March 2020

Source: Australian Bureau of Statistics

Given this backdrop, it is impossible to see how aggregate demand in the economy can hold up, with even the Federal Treasurer stating that the economy is bleeding to the tune of $4 billion a week whilst we remain in quasi-lockdown, with economic output likely to drop 10% this quarter.

For as long as this continues, companies are almost certain to see a massive hit to their sales figures, and to their profits, which can’t help but weight on share prices going forward.

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It’s been another positive week on the coronavirus front, with rates of infection in Australia continuing to slow, whilst financial markets (apart from oil) have been calm, at least relative to the extreme volatility seen in March of this year.

Given this backdrop, we thought it appropriate to use this week’s “In the Loupe” to touch on three key areas of relevance to our readers at Australian Diamond Portfolio.

• The shocks to the Australian economy that continue to build.
• Why household frugality is the new normal.
• Why high levels of equity market concentration are a growing risk for investors.

These developments are all linked, and combined will continue to encourage investors to allocate part of their portfolio to tangible assets like pink diamonds.

So far this year, pink diamonds have again shown their ability to hold their value, despite the unprecedented challenges we face. As you’ll see below, we don’t expect that to change anytime soon, with the role they can play both protecting and enhancing wealth becoming clearer by the day.

Australian Economic Shock to Build

Whilst the news regarding the slowing spread of coronavirus continues to get better, with some restrictions on movement and socialising lifted in certain states, the news about the economy only continues to deteriorate.

Modelling by Ernst and Young suggests the lockdown we are currently in could cost up to $400bn over a six-month period should most restrictions remain in place, a number that is closer to 20% of our total economic output.

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Stock markets have remained relatively calm over the last week, with the spread of coronavirus continuing to slow, and some countries beginning to talk about easing restrictions on human movement in the foreseeable future.

This includes Australia, where the government have suggested that some services, including elective surgeries, will be allowed again, with the ban on these set to be lifted after the ANZAC day long weekend.

Whilst we welcome any and all signs that life is heading back to normal, we’d note that from a health perspective, and from a financial perspective in particular, we are far from out of the woods, with investors likely to face continued uncertainty for the foreseeable future.

If you need any further evidence of how far out of whack things are in the real economy right now, consider that this week, the price of oil fell below zero. We don’t wish to sound alarmist, but we can’t but help think we face some very difficult years ahead of us if oil, the most important commodity powering the industrialised economy is literally worthless.

Make no mistake, there will not be a quick return to normality from the economic damage caused by coronavirus, with the economy likely to get substantially worse in the coming months. Central banks can try and print our way out of this crisis (and they are trying, as you can see in the chart below which plots the exploding rate of money printing), but it will not work.

12m rolling change in G10 Central Banks’ Balance Sheet (USD billions)

Sources: Deutsche Bank, Bloomberg Finance L.P, Datastream.

Instead, what all of this currency printing will do is encourage investors to put their money into hard assets, which will be a tailwind for unique asset classes like pink diamonds for years to come.

The importance of specialisation

With the economy and financial markets going through a period of unprecedented volatility, it should be no surprise that some luxury items are struggling to find the same level of buyers, with people closing their wallets.

Pink diamonds have of course been totally unaffected by this sell off, with prices slightly rising in the last year in USD terms, and up significantly in AUD terms.

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We hope that you and your loved ones were able to enjoy a relaxing Easter weekend, even if celebrations were obviously more modest than prior years due to the restrictions in place to mitigate the spread of coronavirus.

In Australia, the speed at which the virus is spreading continues to slow, with some arguing that we may soon see some easing of the restrictions on our personal freedoms which we’ve all become accustomed to in the past few weeks.

The relative ‘good news’ that we’ve seen in the past few days as regards the slowing spread of coronavirus is also impacting financial markets, with the US share market recording one of its strongest weeks on record leading into the Easter break.

We have two words of warning for anyone getting too excited by this, thinking that it means we are heading back into a roaring bull market for shares.

The first of those is a look back in time, with market history telling us that essentially all of the “best weeks” on record for share markets have taken place during major bear markets, where over the medium-term, investors lose lots of money. This can be seen in the chart below.

Dow Jones Industrial Average, best weeks on record

Source: Pete Wargent

Note all those amazing weeks during 1931 and 1932. That’s the middle of the Great Depression, with stocks falling about 90% peak to trough. If what we are going through now is a repeat, then you don’t want to own shares.

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Over the last few days, we’ve seen some encouraging news in the battle to control coronavirus, with the number of people getting diagnosed with the disease continuing to increase, but a slower pace than previously.

Whilst this is a good sign, it’s far too early to think the worst is behind us, especially as Australia is still to head into winter, whilst in some countries like the USA and Spain, it appears to be exploding.

Domestically, the impact the coronavirus is having on the economy has been growing by the day and is evident in the 25% decrease we’ve seen in the Australian equity market since late February, as well as a plunging Australian dollar, which is again trading at just USD $0.60.

Both of those factors should serve as important reminders as to why investors should look at pink diamonds, as they have a very solid track record of maintaining value in periods of equity market stress, and they of course benefit from any fall in the value of the Australian dollar.

How about housing?

One other market that hasn’t been getting as much attention in recent weeks, but which we think poses just as much threat to the wealth of many Australians going forward is the Australian housing market.

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The first quarter of 2020 will go down as one of the most volatile in the history of financial markets, with the growing threat of coronavirus, and the emergency steps to contain its spread causing a meltdown in equities markets and huge moves in the value of foreign currencies.

The ASX 200 in Australia lost more than 30% of its value at one point during the month and ended up down by almost 25% for the quarter, its largest quarterly fall on record. Bigger picture, the market is now back at levels first seen in 2006, as the chart below highlights.

Similar moves have also been seen in the S&P500 in the United States and other parts of the developed world, with years of gains wiped out in a matter of months.

The speed of the collapse has caught nearly everyone by surprise and has led to a notable surge in the number of investors looking to diversify and protect their wealth with hard tangible assets.

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