Happy new financial year!
After a very rough first six months of the year, with stocks, bonds, and cryptocurrencies all suffering meaningful price falls, investors will be hoping for a kinder run in the back half of 2022.
It might be easier said than done though, with interest rates continuing to rise (with the RBA hiking the local cash rate by 0.50% to 1.35% on Tuesday this week, with more increases on the way in coming months), inflation continuing to bite, consumer confidence falling, and warning signs of a recession that may hit by next year.
Despite the gloom, there are always pockets of opportunity, especially for those investors astute enough to respond to the circumstances and position their capital accordingly.
Hard assets were one of the few refuges for investors in the last six months, with pink diamonds in particular offering stability, diversification, and ongoing capital growth.
In this week’s market update, we highlight five reasons that this can be expected to continue going forward!
Hard assets to lead the way
Commodities were one of the few bright spots on the investment landscape in the first six months of the year, with almost all other asset classes falling in value.
This can be seen in the chart below, which shows returns for most asset classes to end June 2022.
2022 YTD %
Going forward, there are several reasons to expect commodity prices to continue to perform well, both in absolute terms and relative to other assets.
This was the subject of an excellent research piece that was published earlier in the year, which noted five factors that would support higher commodity prices going forward.
- Higher inflation: As we know, the world is in the midst of an inflation crisis, with consumer prices rising by more than 8% per annum in the United States, the highest levels seen in decades. Europe, Australia, and. the rest of the world are not immune. Higher inflation supports higher commodity prices.
- Demand set to increase: While some might think it’s counterintuitive, the desire to transition to a lower carbon emission, more renewable energy economy will require lots of raw materials, from copper to cobalt to lithium to silver.
- Underinvestment: For most of the last decade, investments from commodity producers have fallen prodigiously. As an example, between 2013 and 2020, capital expenditure in the oil and gas sector fell by 52%, while for the copper industry it was down by 42% over a similar time period.
- A fall in the US Dollar: The USD has been particularly strong of late, but that strength is not expected to last. Bear markets in the USD often last many years and would be supportive of higher commodity prices.
Last but not least, commodities are still very cheap relative to financial assets, and are coming off of an approximately 15-year period of underperformance relative to the share market, as captured in the chart below.
Commodities are cheap on a relative basis
Relative Performance of the commodities1 vs. S&P 500 shown as a ratio
Markets move in long-term cycles.
This chart suggests that for at least the next decade, we are likely to see significant outperformance from commodities and other hard assets.
This obviously includes pink diamonds.
Pink diamonds are special!
The five factors mentioned above, all of which support the case for a continued bull market in hard assets, apply to pink diamonds, which will benefit from these trends.
But pink diamonds also have additional attributes that don’t apply to the broader commodity market, which we expect will further help support price gains in this unique asset class going forward.
These attributes include their stability, with pink diamond prices exhibiting minimal volatility, unlike commodities as a whole, which are notoriously volatile.
Pink diamonds also benefit from extreme scarcity. While all hard assets are by definition limited in supply to some degree, the world is in no real danger of running out of iron ore, or copper, or oil, while over time, some of the demand for these materials will dissipate, as alternatives are found.
In contrast, the annual supply of new pink diamonds to the market dropped by approximately 90% since the closure of the Argyle Mine in late 2020. This supply is not coming back.
Finally, pink diamonds are a special case because the demand for them is not directly linked to the economic cycle.
While we agree with the sentiments that commodities as a whole should outperform other assets in the next few years, the demand for most commodities is directly linked to the growth of the overall economy. If the economy weakens, demand will fall to at least some degree, which over time can be expected to curtail price growth.
Pink diamonds are different, as their demand is driven by those looking for a display of wealth, and/or those wanting to own them as an investment asset due to their inflation protecting qualities, ability to diversify a portfolio, and ability to deliver strong long-term returns.
These factors combined bode well for the pink diamond market going forward, with prices expected to continue growing for the foreseeable future.
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.