30 May

Investing against the grain

It’s hard to believe that the year is already one-third of the way through.

For investors, it’s been a year of uncertainty thus far, with stock markets giving back all of their early gains (in Australia at least), and property markets starting to slow down. The high-risk cryptocurrency market has remained notoriously volatile, with Bitcoin down almost 15% in the last month, and back below where it was trading in November 2021.

In terms of the pink diamond trade, it’s been a quieter quarter as investors sit tight on their holdings. Market conditions have seen demand and overall turnover level off.  While we’re currently not seeing the spectacular growth from a few years back, prices continue to stay steady, mainly driven by supply constraints.

Moving forward, we expect a range of catalysts, from persistent inflation to warnings of an economic slowdown in both Australia and other parts of the world to push demand, as well as prices, higher.

Interest rates, which way they are going to move, and their impact on investment markets lie at the heart of the evolving outlook for the pink diamond market, and why we believe things look favourable for our favourite investment and asset class.

Find out more below.

This will change everything

It was six months ago that the Reserve Bank of Australia last hiked interest rates, with a 0.25% increase bringing the local cash rate to 4.35%.

The move was deemed unnecessary by many commentators (politicians of all stripes and indeed many economic commentators called them out at the time), while for nearly all analysts, it was seen as the absolute top of the interest rate cycle.

As a result, most market commentators and investors approached 2024 thinking that this would be the year that interest rates would start to fall, marking a new cycle of easier money that would support the economy, as well as asset prices from cryptocurrencies to the share market to property.

Events have not turned out that way, for the very simple reason that while higher interest rates have slowed the economy down, they have not been anywhere near as successful in combatting inflation, with consumer prices in Australia and other parts of the world continuing to rise at an uncomfortable rate.

As a result, not only are interest rates at risk of not falling at all this year, but they may in fact rise, with some economists now thinking rates could head above 5% in Australia this year.

There is also the risk of further upside in America too, with the US Federal Reserve potentially being backed into a corner in their attempt to control inflation.

To highlight how significant the inflation problem remains in America, consider the below chart (sourced here) which shows not only headline inflation (the yellow line) but also three other metrics that measure the pace of price rises across the economy.

Median Consumer Price Index

Chart of Median Consumer Price Index

Source: Bureau of Labor Statistics, Federal Reserve Bank of Cleveland, Haver Analytics.

The chart makes it clear that not only is inflation no longer falling, but it’s starting to heat up again. Indeed, headline monthly inflation has risen from 0.2% month on month in December 2023, which would equate to roughly 2.5% as a yearly inflation result, to 0.4% month on month by March 2024.

That would lead to headline inflation of close to 5% per annum if the recent pace of price increases is maintained.

This problem is also extremely relevant to Australian households, consumers and investors, with price rises in Australia arguably more entrenched than they are overseas.

For evidence of this, consider the below extract from a Commonwealth Bank of Australia research note, who looked into local inflation data and found that:

  • Non-discretionary prices rose by 4.2%/yr, while discretionary (ex. tobacco) inflation eased to 2.3%/yr.
  • The key drivers of inflationary pressures in Australia are centred around parts of the CPI basket where consumer demand is less able to respond to higher prices.
  • Eight of the top 10 contributors to the quarterly increase in prices were non-discretionary items: rents, secondary education, health services and pharmaceuticals, new dwelling construction costs, vegetables, and insurance and other financial services.

Given this backdrop, it is no wonder that Australia is in what they call a ‘per capita recession’, where the economy is growing in absolute terms, but not on a per person basis, with disposable incomes falling by more than 5% last year.

Higher inflation is problematic, full stop.

However, when it’s driven by increases in the things we need to spend money on (ie. we can’t very well not eat or not put a roof over our heads) versus the things we want to spend money on (for example holidays, a new car or household appliances and furniture) then it is a recipe for huge problems, both in the economy, and in investment markets.

This is where pink diamonds come in, as we’ll discuss below.

Investing against the grain

At first glance, it might seem somewhat counterintuitive to associate higher inflation and greater economic uncertainty with a brighter outlook for pink diamonds. After all, if people have less money to invest, won’t they be less likely to buy assets like pink diamonds?

In the short term, the above logic rings true, hence the reason that we are seeing the slowdown in diamond demand, relative to previous years. On balance in the long term however, the kind of economic and investment environment currently playing out may actually be very positive for pink diamonds.

The reasons the current environment may be positive for our favourite asset class will not be news to long-term readers of these updates, and include:

  • Higher inflation is by default bad for assets that only offer income as a form of return, like cash in the bank or a term deposit. While interest rates offer some compensation to protect against inflation, there is no doubt that higher and more persistent inflation will encourage investors to move at least some of their wealth out of cash. Pink diamonds stand to benefit from this as investors turn to hard assets with a history of protecting wealth in high inflation environments.
  • Higher inflation, especially when combined with higher interest rates, is a huge headwind to property prices, as it impacts both what people can borrow, and what kind of mortgage they can service. Pink diamonds may benefit as investors search for alternative investments in such an environment.
  • Higher inflation, especially when it is most pronounced in the “must have” items people spend money on, is a huge negative for the share-market, as consumers, who have less free cashflow to spend, cut back on their spending. Pink diamonds may benefit from this as investors seek diversification and protection from the potential for large falls in the share market.

These are three great reasons to invest in pink diamonds now.

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


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