It’s been another busy week in financial markets and in the diamond world. This week we wanted to share three topics of interest with you, including a look at the proposed initial public offering (IPO) for WeWork, the shared office space company, as well as interesting economic news out of India. Combined, we think these elements bode well for coloured diamond prices in the years ahead.

Finally, we also look at two stories from the diamond world and why it’s looking like Australia may not have any diamond mining industry at all by the end of 2020, with supply shutting down completely.

Indian Government to Print Money to pay for Tax Cuts

Whilst most market attention was focused on another interest rate cut by the United States Federal Reserve last week, and a short-term spike in US funding markets, we were more interested by an announcement that the Indian government will be cutting corporate tax rates, in a bid to stimulate economic growth.

Whilst we are generally speaking a big fan of lower taxes, we couldn’t help but notice that the Indian government effectively plans to pay for this tax cut (in terms of replacing the income it will forego) via printed money from the Central Bank of India.

This headline from Bloomberg sums up the news.

In our opinion this is just another step on the obscene monetary path that authorities have decided to take us down in the ten years since the Global Financial Crisis (GFC) ended.

The only likely outcome from this is the one alluded to in the subheading above, with weakness in the Indian currency, and higher inflation almost certain to arrive.

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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.

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.

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It seems barely a month goes by without some high-profile commentator from the funds management industry warning about the risks in financial markets; and why investors should be protecting their wealth with tangible hard assets.

This time around, it’s the world’s largest asset manager, Blackrock, who last week published an article titled; “The monetary policy endgame”.

The article looks at the current state of financial markets, discussing some of the themes we have been talking about with readers of “In the Loupe” this year, including the implications of negative interest rates.

Most importantly the article looks at what central banks will do in the years ahead. Their key takeaways are as follows:

• Don’t expect today’s low interest rates to go away anytime soon as according to Blackrock, real interest rates will need to be negative for the foreseeable future.
• Don’t be surprised if we see helicopter money, which is basically central banks printing money outright and giving it to people to spend.
• Expect to see a currency war, as countries engage in what is called competitive devaluation, each trying to push down the value of their own currency more than other nations.

We could potentially see helicopter money – central banks printing money outright and giving it to people to spend.

What can an investor do?

The article itself ponders the investment implications of such a monetary environment, noting that any “nominal instrument will be devalued in real terms”. This means that going forward, whilst cash will still be useful for day to day transactions, it looks like it will be useless as a savings asset as it will continue to lose value.

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In last week’s “In the Loupe”, we discussed the short period of calm that had descended on financial markets, noting that whilst many investors were no doubt hoping the worst was behind us, we weren’t so sure, and that in our view, things could yet deteriorate in the months ahead.

Fast forward just seven days and it appears we were right to be concerned, with markets badly rattled by an escalation in the trade war between the United States and China.

They say a picture paints a thousand words, and the one below, which coincided with a story about the plunge on the ASX on Monday 26th August, which followed on from strong losses on Wall Street last Friday, captures the mood of the investment community right now.

Source: News.com.au

What happened?

This time around, the latest escalation in trade tensions between China and the United States started in Beijing, with the Chinese government announcing retaliatory tariffs on $US75 billion of US goods last Friday, as well as reinstating duties on US car exports to China.

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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.

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.

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We wanted to send you this special market update, which comes the day after another bloodbath on global equity markets, including in Australia, where the ASX 200 dropped almost 3%.

As yesterday made clear, there is no shortage of risk factors for investors to navigate right now, many of which we have warned clients of Australian Diamond Portfolio about recently.

These include negative interest rates around the world, crashing commodity prices, inversion of the yield curve, and continued fears over the US-China trade war.

All of those things have been in the news in the last 24 hours, with the pool of negative yielding debt (which we wrote about in this weeks “In the Loupe) now surging beyond USD $16 trillion, as the below Bloomberg chart shows.

Meanwhile, the odds of a recession in the United States, Europe and other parts of the world continue to rise, with the US yield curve inverting for the first time since 2007, which was right before the Global Financial Crisis kicked off.

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It seems barely a week goes by without some development in financial markets and in the economy that supports the investment case for rare coloured diamonds.

Seven days ago, we touched on an important article by hedge fund manager Ray Dalio. Titled “Paradigm Shifts”, we explained why Dalio’s forecasts for the decade ahead will see demand for alternative assets like pink diamonds soar.

Key to this was his prediction that; “holders of debt will receive very low or negative nominal and real returns in currencies that are weakening.”

Just one week later, and we’re seeing this come to pass with the news that countries like Germany, Switzerland and Austria now have negative bond yields out to 50 years, whilst the global pool of negative yielding debt recently topped USD $15 trillion, which is about ten times the size of the Australian economy.

What is a negative yield?

A negative yield is a scenario where an investment, like a government bond, will earn the investor less than zero (i.e. they are guaranteed to lose money) if they hold their investment until the bond matures, and the issuer repays the principal.

In Germany and Switzerland today, government bonds that have maturities ranging from the very short-term (less than a year) to the very long-term (up to fifty years) are all trading at negative yields.

Effectively, investors are paying these governments for the privilege of lending money to them. This is unprecedented in thousands of years of recorded human history.

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Ray Dalio is the founder, co-chief investment officer and co-chairman of Bridgewater Associates, one of the largest hedge funds in the world, with assets under management of over USD $125 billion.

He is a genuine heavy hitter in the asset management industry, and when he talks the markets tend to listen.

The reason I’m sharing this is because just over two weeks ago, on the 18th July 2019, Dalio published a widely read and quoted article on LinkedIn titled “Paradigm Shifts”, as well as an even more detailed research piece on the same subject.

“Paradigm Shifts” looks at the changing economic, political and financial market environments that have occurred over the past 100 years, with Dalio starting his research piece by sharing one of his famous Investment Principles, in this case noting how important it is to; “Identify the paradigm you’re in, examine if and how it is unsustainable, and visualize how the paradigm shift will transpire when that which is unsustainable stops.”

Ray Dalio – founder, co-chief investment officer and co-chairman of Bridgewater Associates which has assets under management of over USD $125 billion.

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Some of the team from Australian Diamond Portfolio, myself included, have just completed three days on the Gold Coast, where we attended this year’s Australian Investors’ Association National Conference.

Aptly titled; “Investing Beyond the Boom”, the theme of the conference and the data presented very much reinforced why investors needs to look at alternative solutions in an age where property markets are still jittery, cash rates are at all-time lows and falling, whilst equity and bond markets are at all-time highs, with risks everywhere.

Given this background, we were delighted, though not surprised to witness first-hand the interest from would be investors in alternative assets like rare coloured diamonds, with our booth swamped with inquiries over the three days.

One talk in particular, titled “Is Australia About to Run out of Luck”, delivered by highly respected independent economist Gerard Minack shone a spotlight on the risks in the economy right now.

What did this talk highlight?

Minack’s talk, and other material he has published this year essentially covered the downside risks to the economy, looking at falls in house prices, and the negative wealth effect this has as consumers close their wallets and try to save more. This was something we covered in last week’s “In the Loupe” where we included four charts which combined, give us great concerns regarding the ongoing risk in the housing market.

Other factors included the fall in building approvals, which by definition means less work for those in construction, with all the negative implications that has for income growth and consumer spending etc.

Most importantly, it will negatively impact employment, where leading indicators are weakening, which means unemployment and/or underemployment may well rise in the months and year ahead.

Add it all up, and Australia is a facing tough road in the next 10 years economically, with a real chance of recession. None of us can control that, but we can make sure our portfolios are positioned to protect and grow wealth as these economic forces play out.

Australian Diamond Portfolio at the 2019 AIA Conference

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