05 Oct

Inflation protection and pink diamonds

It was yet another tumultuous week for investors, with asset markets worldwide continuing their recent sell-off, driven by an escalation in tensions between Russia and Europe, and heightened volatility in UK financial markets.

Even if markets were to stabilise in the coming weeks, and this remains a big if, 2022 is shaping up as one of the worst on record for most investors, with shares, property, and crypto all falling, and even commodity markets have given back a lot of the significant gains that they made earlier in the year.

There are of course some assets which are acting as exceptions to the rule, including the market for pink diamonds, which is still seeing strong demand and steady price growth.

Our article this week reinforces why diamonds are looking more attractive to a wider range of buyers today, and why inflation is compounding the challenge those managing their own portfolio currently face.

Inflation and the sell-off in asset markets

It’s easy enough to think that if you own an asset that falls 20% in value from its all-time high, then you need it to increase by 20% in order to get back to breakeven.

Unfortunately, that’s not the case. Indeed, in such a situation, an investor would still be down 4% from the value seen at the all-time high, as the following simple example highlights.


Table of asset loss and break even point.

Indeed, for an asset to fully recover from a 20% decline, it needs to rally by a full 25% from the point at which it stopped falling.

The table below shows how much of a gain is needed to fully recover a fall in the value of an investment, depending on the size of the decline from the peak.

Table of increases after declines to break even.

For investors in the share market, in cryptocurrencies, or even Australian property, tables like this can be instructive.

After last week’s trading, the S&P 500 in the United States is down approximately 25% over the course of the year.

This means that it needs to rally 33% to get back to where it was.

Bitcoin is down 60%. It needs to rally 150% to get back to breakeven, while in Australia, there are many forecasters that now think the local property market will fall by up to 30%, wiping out the gains seen during the pandemic.

If they are right, then real estate prices in Australia, once they’ve finished falling, will then need to climb by 43% to get back to where they were in early 2022.

In reality, inflation makes this challenge even worse, because the value of money does not remain constant over time.

You don’t just need to get your portfolio back to where it once was in dollar terms in order to break-even; it needs to go further than that, to make up for the loss of purchasing power suffered during the period that the asset is falling, and then recovering.

This problem is particularly acute today, given the surging inflation we’ve seen across Europe, the UK, the United States and of course Australia.

For example, let’s assume that:

  • a market or a particular asset falls by 20% over 2 years.
  • in that period, the total increase in consumer prices, or inflation, is 15% across the two years, which is not an unreasonable assumption given current market dynamics.

In such a scenario, the asset in question needs to rise by 44% to get back to a real break-even level, not just 25% as per the above table, which only looks at nominal dollar values (i.e. it doesn’t adjust for inflation).

The table below provides more detail on this phenomenon, looking at the gains needed to get back to a real breakeven point assuming 15% inflation, and how much additional return this represents.

Table of break even points with inflation factored in.

Using a potential 30% fall in Australian property as an example, and what we see is that rather than needing to rise by 43% to get back to break-even, it would need to rise by 64% if inflation pushed consumer prices up by 15% in the time period the market was first falling, and then beginning to recover those falls.

The table makes it clear that inflation drastically alters the challenge that investors in most asset classes are facing today, and not in a good way; it makes the mountain they must climb to recover the losses they are suffering this year all the harder to climb.

Given this backdrop, it should be no surprise to see assets that can mitigate this risk grow in popularity.

Diamonds are beautiful in more ways than one

Given the challenges that investors are facing in the markets today, it’s no surprise that more of them are looking to add pink diamonds to their portfolio, joining buyers of high-end jewellery and other high-net worth individuals who’ve always shown an affinity for these scarce assets.

While the beauty of pink diamonds in a physical sense is obvious to anyone who has ever seen one, and especially anyone who has held a pink diamond in their hand or viewed one through a loupe, that’s not where their beauty ends.

Their allure goes beyond the physical, and includes the fact these assets have delivered very strong long-term returns (circa 600% in the past 15-20 years), and that at present, these pink diamonds are not suffering in the same way that most of the asset classes that we have discussed in this update are.

Rather than needing to now see large gains just to get back to a break-even position, pink diamonds, rather than falling, have been one of the few assets that have not only matched, but exceeded inflation in recent times.

No one can guarantee how long this might continue, but based on our interaction with clients at Australian Diamond Portfolio, there is little doubt that this is a major factor driving demand for these assets today.

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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