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.
Look at the big picture
When looking at any market indicator, be it foreign exchange rates, stock market valuations etc, it always pays to look at long-term trends. Doing this allows you to get a better sense of where the market sits today relative to historical readings.
The chart below plots the AUDUSD FX rate over the last thirty years, going all the way back to the last recession we had in Australia.
AUDUSD FX rate
As you can see, there have been three primary trends in the AUDUSD FX rate over the past thirty years.
- Decline in the value of the AUD, with it falling from close to USD $0.80 at the start of the 1990s to below USD $0.50 by 2001
- Increase in the value of the AUD, with it rising from below USD $0.50 in 2011 to roughly USD $1.10 by 2011
- Decline in the value of the AUD from USD $1.10 since 2011, with the currency sitting close to USD $0.70 today
The chart suggests that whilst the Australian dollar is not as expensive as it was in 2011, it is a long way from cheap relative to the USD.
This is especially relevant considering Australia is now almost certainly in a recession, with high household debts complicating the path forward for the Australian economy.
Remember that in the aftermath of Australia’s last recession, the currency lost almost 40% of its value against the USD, with the decline taking roughly a decade to play out. The situation is of course different in many ways this time around, but if a similar performance trajectory were to occur again it would imply the AUD could fall all the way down to USD $0.43 in the years ahead.
Note that this is not a prediction per se, but it is also not something we think investors should totally rule out. The fact that the RBA has now cut rates to 0.25% (with some economists openly encouraging them to push rates below zero) and has also begun printing money only adds to the downside risks for the AUD in the months and years ahead.
Take advantage of the opportunity
For example, if you were looking to invest AUD $100,000 back in late March, then that would only have allowed you to purchase a stone valued at USD $55,000. That same AUD $100,000 investment will buy you a stone worth closer to USD $70,000 today.
Should the AUD return to its lows of USD $0.55 in the months and years to come, then this currency move alone would increase the value of your AUD $100,000 investment to AUD $127,000.
Note that this gain of AUD $27,000 is before one allows for either;
- The AUD to fall below its March lows (remembering it dropped below USD $0.50 back in 2001)
- The prices of pink diamond investments themselves to appreciate
We suspect the latter is unlikely, given pink diamonds have historically delivered returns of over 10% per annum, and the fact that the Argyle Diamond Mine is closing this year.
Bottom line: From our perspective, the AUD rally of the last two months is a gift for prospective pink diamond investors.
As always, we hope you’ve enjoyed this week’s edition of “In the Loupe” and look forward to any questions or comments you may have.