27 Apr

Pink diamonds continue to impress!

Welcome back to our regular market updates, and on behalf of the entire Australian Diamond Portfolio team, we hope that you and your loved ones enjoyed fantastic Easter and Anzac Day long weekends.

While many of us would have understandably taken the chance to refresh (it’s hard to believe the year is almost one third over already), it has been anything but a quiet time in investment markets.

Indeed, over the last couple of weeks we’ve seen:

  • A sharp fall in the Australian dollar, which is down about 5% this month, and now trading just above USD $0.71.
  • Renewed volatility in equity markets, with the ASX down over 3% in the last week.
  • Oil prices drop back toward USD $100 per barrel, down several percentage points in the last couple of weeks.

The situation in the Ukraine continues to remain tense, while China is locking down large parts of the country in an attempt to contain the latest outbreak of COVID-19.

Those lockdowns will continue to fuel inflationary pressures, with market expectations of what inflation will average in the next decade now sitting close to all-time highs.

Meanwhile, in developed markets like the United States, signs of a major economic slowdown, and a potential recession continue to build, something we have warned about for some time.

This is the perfect scenario for alternative assets like pink diamonds to flourish, and indeed that is exactly what they are doing, as we touch on below.

Before that though, we look at an indicator that highlights why inflation pressures won’t go away anytime soon, and how much of an impact higher costs of living are already having for many people out there.

Supply and demand can’t be fooled

According to all the economics textbooks, prices of any particular item are determined by supply and demand. And as a general rule, given no one likes to leave money on the table, if the price of something goes up, someone will make/produce more of it, so they can sell it at a profit. This typically helps keep inflation in check over the long-run.

Today though, in energy markets at least, these dynamics are broken, as a heightened environmental focus, especially in the developed world, means that companies have pumped the brakes on exploring for and ultimately producing more energy, even though prices have skyrocketed since the lows seen during 2020.

This can easily be visualised through the chart below, which shows the price of crude oil (black line), and what is called the oil sector capex to assets ratio (pink line).

Crude Oil Outlook: Supply Tailwind Baked-in

Chart showing the outlook for crude oil

Source: Topdown Charts, Refinitiv Datastream

In essence, the oil sector capex to assets ratio measures the amount of capital investment (capex) oil companies are undertaking, relative to the value of their assets.

Logically, if the oil price goes up, then the value of an oil companies’ assets goes up, but so too does their incentive to produce more. Hence, you’d expect these two lines to follow each other closely, and indeed for most of the period from the early 1980s to 2010 or so, they did.

Since 2011 though, everything has changed, with capital investment continuing to plummet. No capital investment means no capacity to increase supply.

When higher demand runs into stagnant or declining supply, you can expect prices to rise. (Note that the pink diamond market has an even stronger version of these dynamics at play today, and will do so for years to come.)

Given how important oil, and energy more broadly is to overall inflation rates – this means higher inflation on average going forward.

In terms of how much of an impact inflation is already having, consider the chart below, which shows the market value of two high profile companies, Netflix (which we subscribe to), and Exxon Mobil.

Graph showing Netflix and Exxon Mobil market caps

Source: Compound @CharlieBilello.

Note how two years ago Exxon had plunged, and Netflix overtook it, with the streaming company having a larger market capitalization than Exxon at the start of this year.

Since then Exxon has continued to boom, while Netflix has plunged, falling 35% in a day last week as the company saw a decline in paid subscribers for the first time ever.

People want Netflix, but they can live without it. It’s not so easy to live without energy.

While these are troubling developments, the only tangible thing any one of us can do is make sure our own wealth, and our investment portfolios, are well positioned to survive, and indeed prosper during this inflationary storm.

Pink diamonds can play a pivotal role in that regard.

Pink diamond market going strong

Unlike other markets which are seeing renewed volatility, pink diamonds are going from strength to strength, and are seeing continued price appreciation.

News articles attest to this, though they tend to focus on the absolute top end of town, with high profile auction houses like Christies recently auctioning off a US $6.7 million 8.8 carat pink diamond dubbed ‘The Fuchsia Rose’.

This wasn’t the only pink diamond that featured in the “Magnificent Jewels” auction by Christies, with a 2.44 carat fancy intense pink fetching US $1.6 million, with the entire auction generating more than US $25 million in transactions.

While transactions of this size understandably generate lots of attention and occasional media buzz, the strength in the pink diamond market is not limited to those buying ultra-expensive stones.

Indeed, our Australian Diamond Portfolio Pink Diamond Index (ADPPDI), which we update quarterly, is showing continued impressive returns, with our figures to the end of Q1 2022 set to be released within the next week.

For those who are still considering taking the plunge into this truly rare asset class, the returns should give some sense of the investment opportunity pink diamonds can offer.

Watch this space.

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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