20 Sep 2019

Inflation Protection and the role of Pink Diamonds

The biggest news in markets over the last week has been the attacks on the Abqaiq oil facilities in Saudi Arabia.

The attacks, which amount to one of the biggest disruptions to oil supply on record are expected to temporarily remove half of Saudi oil output, with global production likely to be cut by 5%.

The reaction in markets has been quick and severe, with the price of oil jumping 20% higher at one point, the biggest price move since the 1980’s.

The situation may take months to resolve and indeed could deteriorate in the period ahead, with tensions between the United States and Iran (who are being blamed for the attack) already fraying.

What does it Mean?

In short, the oil price spike is likely to lead to both higher inflation, as well as lower growth, adding to the recessionary fears that are already well-established given market concern about negative yielding sovereign bonds and an inverted yield curve in the United States.

For evidence of the impact of an oil price shock, consider the chart below, which comes from Oxford Economics. It shows the impact on growth rates and on inflation rates in various oil price scenarios.

Impact of rising oil prices

Source: Oxford Economics

The chart highlights the fact that as the oil price rises, we should expect to see GDP growth decline and inflation rise. That’s the worst of all outcomes, with John Payne from Oxford Economics stating that higher oil prices could push global inflation rates toward 5%.

To protect against this eventuality, it’s vital that investors have exposure to tangible hard assets, which can protect against inflation. Rare coloured diamonds are one such asset class.

Meanwhile in Europe

As if an oil shock wasn’t enough to rattle investors, we also saw the European Central Bank (ECB) in action last week, offering again to stimulate the European economy.

And by stimulate – we mean cutting interest rates even further and printing more money. The ECB relaunched a 2.6 trillion EUR quantitative easing plan to buy bonds, stating that from November 2019 they will print 20 billion EUR a month to buy such bonds.

The ECB also cut its main deposit rate from -0.40% to -0.50%, further punishing savers who wish to keep their money in the bank.

They aren’t going to stop there either, with even more radical ideas being proposed, including one where the ECB would deposit money directly into the bank accounts of European citizens, according to an article in the Financial Times.

Over time actions like this from the ECB and their central banking counterparts in the United States, the United Kingdom, Japan and indeed Australia will contribute to ever higher levels of inflation, and see investors seek out tangible assets like rare coloured diamonds.

Diamonds protect against inflation

Whilst developments in Saudi Arabia and at the ECB in the last week are “news”, they are in many ways continuations of trends that have been in place for up to two decades.

Conflict in the Middle East is hardly new, with tension between Washington and Iraq, Syria, Iran (pick your country) elevated since September 11 2001.

Meanwhile when it comes to central banks, a 2019 report by fund managers Perpetual Investments highlights the fact that there have been over 700 interest rate cuts since the Global Financial Crisis (GFC) hit, with central banks also printing over USD $14 trillion in that time.

All this has contributed to inflation, much of which has been capitalized into higher asset prices. And none have prospered more than rare coloured diamonds, with the table below (which comes from our 2019 Pink Diamond Investment guide) highlighting the market beating performance of pink diamonds from 2005 to 2019.

 

Returns Across Asset Classes 2005-2019

Asset ClassTotal Growth (%)Annualised & p.a.
Pink Diamond Index362.211.6
Intense Pink Diamonds (All Intense)385.812.0
Vivid Pink Diamonds (All Vivids)402.612.2
Silver (USD)135.96.3
Cash75.54.1
Australian Shares201.48.2
International Shares135.26.3
Balanced Managed Funds129.16.1
Growth Managed Funds157.97.0
Australian Listed Property114.45.6
Australian Bonds117.35.7
International Bonds144.76.6
Gold (USD)204.68.3

 

We might be oversimplifying it, but we think the case for rare coloured diamonds remains incredibly strong. After all, we are in an environment where we are seeing more of the same from central banks in terms of monetary stimulus, as well as continued fears over an economic slowdown and the risk of a sharp correction in equity markets.

Demand will only increase in such an environment. This alone would be enough to push prices higher, but given it will happen in an environment where the Argyle Mine is shutting, and supply is going to be cut by up to 90%, then the results could be spectacular, with the investment potential in this unique asset clear for all to see.

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

 

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