It’s been another interesting week in financial markets, with equity prices continuing to climb, whilst bond prices are falling. Whilst it’s the former that is getting all the attention, it’s the latter that we think is more interesting, as falling bond prices are a sign that the market might be starting to get worried about higher rates of inflation.
Should higher inflation come to pass in the years ahead, it will be another tailwind supporting higher pink diamond prices, given their scarcity, and ability to hold their value over time.
Last week, we focused on the incredible rise in the Australian dollar, which has climbed above USD $0.70, a near 30% rally in just over 2 months, and why that is a gift for potential pink diamond investors.
In this update, we are going to focus on interest rates and why we now expect them to go below zero in the coming months in Australia. Most importantly, we’ll touch on why this development will further bolster pink diamond investments.
A Story Decades in the Making
Low interest rates are not a new phenomenon, with rates declining around much of the globe since the early 1980s. In Australia, interest rates have been declining since the early 1990s at least, which can be seen in this chart below from the Reserve Bank of Australia (RBA).
Graph of the Cash Rate Target
From a high of 17.50% in 1990 to their current low of 0.25%, interest rates have fallen 99% in the past 30 years. This has obviously boosted asset prices, but it has also helped fuel a huge private debt bubble that has led Australian households to become the second most indebted (relative to economic output) in the Western world.
Amazingly, even though rates have fallen from over 7% in 2008 to just 0.25% today, Australian’s are still spending as much on mortgage repayments today as they were just over 10 years ago.
This is the number one reason why interest rates can’t be allowed to rise, because it would cause a huge increase in financial stress for Australian households, and likely lead to a crash in the property market.
Economists, rather than acknowledging the problems caused by ultra-low interest rates, are instead agitating for the RBA to push them even lower, arguing they should go below zero in the months to come.
The most high profile of these is probably Westpac Bank’s Bill Evans, who in early June noted that: “A serious case can be made for the RBA to consider further cuts and entering negative territory for the cash rate if it becomes apparent that the economy is deteriorating even more than is currently expected.”
Doing so will supposedly allow businesses and mortgage holders to borrow at even lower rates, with the argument being that the extra debt, and the spending it will facilitate will boost the economy.
Call us sceptical, but if a 99% decline in interest rates over 30 years to all-time record lows isn’t enough to stimulate business demand, then we aren’t sure further rate cuts will do anything effective.
We are also in no way convinced that it will be a positive for the economy if households are encouraged to go even further into debt in the years to come, given their existing debt burden, and the fact the country is now officially in a recession, facing its largest economic challenge in 100 years.
If negative interest rates are tried in Australia, and we expect they will, then we can be sure that a few things will happen, based on historical observation.
First, for certain sections of the community, like retirees, it will negatively impact spending, as people with savings cut back due to the declining rates of interest they are earning.
Secondly, negative interest rates will fuel greater financial instability.
Thirdly, negative rates will act as a drag on the currency, helping push down the value of the Australian dollar.
All of those factors are positives when it comes to investors looking for alternative assets, including pink diamonds.
Protect Yourself and Profit
The trend towards ever lower and eventually negative interest rates that we’ve discussed in this week’s “In the Loupe” is largely unstoppable, as are some of the negative impacts it will have on the economy as a whole.
As individuals there is nothing we can do to alter the course of monetary policy in Australia, with the money we earn, and the money we save in the bank having its value destroyed little by little, as a matter of official policy.
What we can do is position our investments so that we not only protect ourselves from these developments but benefit from them. Every week we speak with clients at Australian Diamond Portfolio who see troubles building in the financial system.
This awareness, coupled with the unique attributes that pink diamonds, a genuinely scare and highly coveted asset class, offer as investments is seeing demand continue to build.
These astute investors know they are better storing their wealth in an asset that has delivered long-run returns in excess of 10% per annum, rather than keep their money in the bank with more or less no interest, and less than the rate of inflation.
As William Arthur Ward once said; “the pessimist complains about the wind; the optimist expects it to change; the realist adjusts the sails”.
It’s time to adjust the sails.
As always, we hope you’ve enjoyed this week’s edition of “In the Loupe” and look forward to any questions or comments you may have.