21 Aug 2019

How low can the Australian Dollar Go?

It’s been a tumultuous few weeks in financial markets to say the least, with tens of billions of dollars of financial wealth going up in smoke. Rare coloured diamond investors have largely been immune to this wealth destruction, with prices edging higher in recent months.

Meanwhile the fall in the Australian dollar has boosted returns for local investors, which is a trend we expect to accelerate in the years ahead.

In this week’s “In the Loupe”, we explore a handful of topics including:

  • Will the volatility in financial markets end soon?
  • Is your superannuation safe?
  • How low can the Australian dollar go?
  • Auction expectations for rare coloured diamonds

When will the Volatility End?

Investors will have been relieved to see a small gain in equity markets on Monday 19th August. After a savage sell off in previous weeks, any respite is welcome, with many no doubt hoping the worst is behind us.

We for one aren’t so sure, and think things may well get worse in the months ahead.

Economic data for one isn’t improving, with recent data out of Japan (still one of the world’s largest economies and a key export market for Australia) showing a 10% year-on-year fall in exports to China, its biggest trading partner.

For further evidence of the risks that still exist in the market, consider the chart below from ANZ, which plots how volatile markets can get during periods of severe stress over the last twenty five years. In the chart, the higher the line, the more volatile the market was.

What the chart is telling us is that the recent volatility caused by trade war fears has been nowhere near as significant as previous periods of uncertainty, including the NASDAQ dot-com crash at the end of the 90’s, or the volatility seen when Lehman Brothers folded and the Global Financial Crisis kicked into gear.

Episodes of large volatility

Sources: Bloomberg, ANZ Research

It’s worth remembering that throughout periods like the Global Financial Crisis, rare coloured diamonds were unaffected, seeing steady gains and helping investors protect wealth.

Superannuation: Record Run About to End?

If markets are still at risk, it is probably a good time to think about where your money is invested. Whilst we manage our own SMSF, as it allows us to control costs, and gives us the flexibility to invest in assets like rare coloured diamonds, we still keep a close eye on the returns generated by large superannuation funds.

To that end, we were interested to note the following recent headline from Superannuation research provider Chant West.

A text that says "Super Funds Deliver Ten Straight Positive Years To Break Record".

Record breaking positive gains! What’s not to like, one might wonder?

Well, there are two things to keep in mind when looking at this headline:

  • It measures performance to end June 2019, before this recent bout of volatility savaged markets
  • Periods of record gains tend to be following by periods of record losses

Even Chant West wanted to warn investors, noting that; “it would be a mistake to assume the level of returns we’ve seen recently is sustainable. Indeed, with many asset sectors looking to be fully valued or close to it, we’re expecting some challenging times ahead.”

Make no mistake, we see this as a warning sign, and another signal that the last few weeks’ volatility might be with us for a while yet.

Astute investors should be thinking how to best protect the money they have invested in superannuation. Rare coloured diamonds could be part of that solution.

How Low Could the Aussie Dollar Go?

One of the factors that is driving demand for rare coloured diamonds amongst our clients at Australian Diamond Portfolio is currency diversification.

Any fall in the Australian dollar benefits rare coloured diamond investors, as the diamonds are priced in USD, allowing investors to profit from two trends over time:

  • The rise in the price of rare coloured diamonds themselves
  • The fall in the value of the Australian dollar

Over the last month, we’ve seen the Australian dollar fall notably, with a collapse in the price of iron ore helping drive this fall. A chart of the iron ore price can be seen below, with a circa 25% decline bringing prices back to where they were in early 2019.

Iron ore index

Source: Fastmarkets

Note that despite the falls, iron ore prices are still very high by historical standards. They could fall a lot further in the months and years ahead, and if they do, they’ll help bring the currency down with it.

To help visualise how far the Australian dollar could fall, it helps to look at what has happened in the past. The following chart does that, showing the AUDUSD FX rate (purple line), as well as the bond spread between US and Australian government 10-year bonds (green line) going back to 1999.

By bond spread, we mean the difference between what an Australian government 10-year bond yields, and what a US government 10-year bond yields. For example, if an Australian government 10-year bond had a yield of 3%, and a US government 10-year bond had a yield of 2%, then the bond spread would be 1%.

AUDUSD FX Rate and 10-year bond yield price

Sources: The Perth Mint, Reuters

What do we notice when we look at the chart?

We see that over time, as the bond spread moves up or down, so does the currency. For example, back in 2011, the bond spread was near 2.50% (meaning an Australian government 10-year bond had a yield that was 2.50% higher than a US government 10-year bond), and the AUDUSD FX rate was approximately $1.10.

Today, the bond spread has fallen to -0.50%. Last time it was anywhere near these levels, the AUDUSD FX rate was just $0.50. If history repeats, or rhymes at least, this warning sign is telling us the Australian dollar could lose at least another 25% of its value.

That’s a very good reason to consider investing in rare coloured diamonds, as they will benefit if a currency fall of such magnitude comes to pass.

Diamond Auctions Strong

As a final observation for the week, we wanted to highlight recent news from Sotheby’s, who have stated they expect to fetch nearly $26 million for a 10-carat fancy vivid purplish pink diamond when it is auctioned in Hong Kong.

As an article discussing the pending auction noted, pink fancy colour diamonds have outperformed blue and yellow diamonds, with the imminent closure of the Argyle diamond mine contributing to the upside price pressure.

Add all the factors together and it’s clear that despite the volatility rocking financial markets, rare coloured diamonds remain a rare unique investment opportunity in what is clearly a difficult market environment.

We hope you’ve enjoyed this weeks “In the Loupe”. If there is anything we can do to help you when it comes to investing in rare coloured diamonds, please don’t hesitate to get in touch.

 

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