20 Apr

Commodity indicators and pink diamonds

One of the attractive features of the pink diamond market is the lack of volatility.

While other asset classes, from shares to commodities to cryptocurrencies jump around in price daily, pink diamonds take the slow but steady approach.

While this is actually helpful for investors in this market, who have enjoyed 10%-15% per annum annual returns over the long-run with essentially no drawdowns, it can mean that there are long periods where pink diamonds are essentially out of the news.

This can be a good thing in our view, for while the news flow as regards pink diamonds has been slow of late, the underlying fundamentals remain as strong as ever.

In this week’s market update, we look at several factors that will impact pink diamond demand going forward, and the interplay between them.

These include the outlook for inflation, and for interest rates, two factors which have dominated financial market headlines for much of the last year.

We also look at the ratios for various other commodities, how they are trending, and the implications for asset markets going forward.

Combined, we think they help illustrate why the outlook for pink diamonds remains so strong, and why this niche asset class remains poised for years of outperformance going forward.

Read on below to find out more.

Inflation, interest rates and diamond demand

There are several key factors that drive pink diamond demand. One of these is the desire to first protect wealth from the impact of inflation, and ideally grow it, by holding assets that rise in price at a faster rate than consumer prices.

To this end, it is always critical to keep an eye on the interplay between interest rates and inflation, as much higher levels of interest rates, or lower levels of inflation could in theory dampen pink diamond demand, and stop prices rising at the same pace that they have been.

In the last few months, a scan of the headlines would suggest that we are entering such an environment. After all, interest rates have been rising for most of the last year, not only in Australia, but across most of the world, with rates typically 3-4% higher than they were 12 months ago depending on which country you look at.

Inflation, or the speed of it at least, is also falling. For example, the pace of price increases in the United States dropped from over 9% per annum in the middle of last year to barely 5% now.

There are also factors driving inflation lower, perhaps best represented in the below chart, which shows that global shipping rates (how much it costs to book 40 containers on a freight ship) are now down almost 90% from their peak, with prices now lower than when COVID first hit.

Freightos Baltic Index (FBX): Global Container Freight Index

A chart showing the Freightos Baltic Index (FBX): Global Container Freight Index

Source: CharlieBilello.

Fuel and gas prices are also off circa 15% in the United States, all of which suggests we’ve seen the peak in inflation in this cycle.

Will this be bad for pink diamonds?

We don’t think so, and there are a few reasons why:

  • While lower, inflation is still way too high in most countries. Typically, central banks target 2-3% inflation rates, and 5-6% levels are double where they ‘should’ be. Investors, including those looking at pink diamonds, are still feeling the pinch from this inflation, and understandably looking for alternatives.
  • While interest rates are higher, the money that banks are paying for deposits is still in many cases depressingly low, especially if you want that money ‘at call’ (i.e. not locked away in a term deposit).
  • Interest rate rises might themselves be a thing of the past, or about to stop. The Reserve Bank of Australia (RBA) held rates steady at their last meeting, while there are expectations that rates will not only peak in the United States by June, but that they will begin falling later in the year.

The final factor that will help fuel pink diamond demand is rising recession risk. We touch on this below.

Oil, gold and pink diamonds

The chart below, produced by @CallumThomas, shows the price of a barrel of oil, denominated not in US dollars (which is what you may hear on the financial news at night or read about online), but in ounces of gold.

Analysts like to watch this ratio because oil remains the lifeblood of the industrialised world. If the economy is doing well, demand for oil should be strong, and prices supported, meaning the oil to gold ratio should rise.

But when the economy falters, oil tends to suffer, and the price of oil tends to fall. You can see exactly this happening when COVID hit on the chart below, when this ratio hit an all-time low.

You can also see it beginning to happen again now, with the decline in the ratio predominantly driven by a 25% fall in the price of oil over the last year.

WTI Crude Oil vs Gold

A chart showing WTI Crude Oil vs Gold

Source: Topdown Charts, Refinitiv Datastream.

This chart tells us that there is a rising risk that we may be about to enter a recession, or something very similar to it. Also, the risk is happening against a backdrop of still very high inflation, as per the previous section of this report.

Combined, these factors should be very positive for pink diamond demand, as a recession will almost certainly bring with it less investment into the share market and into real estate, which will likely be at risk.

In their place, we will likely see more investment into assets that have a track record of prospering in such environments, as pink diamonds do.

As always, we hope you’ve enjoyed this week’s edition of “In the Loupe” and we look forward to any questions or comments you may have.


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