27 Jul

Pink diamonds lead way as inflation bites

Inflation results to the end of June in Australia are due for release this week (this report was completed prior to their publication), with forecasts suggesting that the inflation figure, when released, will show that prices in Australia have risen by 6.3% in the year to end June.

It will bring inflation rates to their highest level in decades, as per the chart below, which shows annual changes in Australian consumer prices dating back to the start of the 1990s.

Australia – Annual Inflation Rate

Chart of Australia - Annual Inflation Rate

Source: Australian Bureau of Statistics.

This rate of inflation is far outpacing pay increases, with the latest wage growth data suggesting Australian workers are seeing their take home pay increase by closer to 3%.

Interest rates are also still below 1.5%, while property prices, share markets, and even superannuation funds are all falling in value (more on this below).

Given this backdrop, most Australians are seeing their wealth go backwards.

As a result, it’s no surprise that the inflation problem is challenge number one for economic policymakers, with the Reserve Bank of Australia (RBA) on record stating that it will get worse before it gets better.

Pink diamonds are one of the few assets that are not only keeping pace with, but actually exceeding inflation rates, building the wealth of the astute investors who have added these unique assets to their portfolio.

This is no doubt a major factor behind the very strong levels of demand for pink diamonds that we are seeing today, with their outperformance set to continue.

Where next for markets?

While most of us are hoping inflationary pressures will soon ease off, it pays to be prepared for the worst.

In that sense, it also pays for us to look at developments in other markets, as clearly the performance of other assets like shares and real estate can impact the pink diamond market. 

Starting with property, and the latest data from Core Logic demonstrates a continued decline in property prices nationwide, led by falls in Sydney and Melbourne. We should expect house price falls for some time to come, given that it is expected that interest rates will continue to rise in Australia for another year or so.

Share markets are also giving off warning signs. While they have bounced a few percentage points since late June, there is no real indicator that we are about to enter a new bull market phase.

Indeed, charts like the one below could be seen as warning sign. This chart from the US shows the percentage of client assets held in cash (pink line), as well as the S&P 500 equity index (blue line).

Charles Schwab Client Cash
1993 – 2022

Chart of Charles Schwab Client Cash

Source: Charles Schwab data, Callum Thomas weekly chartstorm.

The chart shows that cash allocations have risen from the record lows seen toward the start of the year. However, it would appear that this is more driven by the market falling, rather than investors panicking and selling, which is usually what you see at/near the end of a bear market.

Cash allocations, at roughly 12.5% of assets today, are at barely half the level that they were sitting at back in the early 2000s and again around late 2008/early 2009, which were times share markets bottomed.

As market commentator Callum Thomas (who shared the above chart) noted (bold underline ours): “Cash allocations (as measured by Charles Schwab — but from my data, confirmed by AAII survey and ICI actual data) have lifted to multi-month highs, but still miles off some of the major contrarian bullish levels seen in recent decades.

This suggests that we may still have plenty of downside to come in share markets. At the very least, it’s something investors should prepare for, and hopefully protect against.

Pink diamonds can play a great role in this regard, acting as effective portfolio diversifiers, and ones that can continue to increase in value even when the share market is falling.

Not so super last year

End of financial year results for most superannuation funds have now been published, with research houses that analyse the entire superannuation sector now releasing their end of financial year updates in the last weeks.

This includes a 19th July release from Chant West, which found that the median growth superannuation fund (most Australians who don’t specifically choose which type of fund they want to invest in are in growth funds) returned -3.3% for the financial year just gone by.

Investors in higher risk growth funds performed even more poorly, as the table below highlights.

Superannuation funds – median returns over 1 year to end June 2022

Table of Superannuation funds – median returns over 1 year to end June 2022

Source: Chant West

While longer-term returns for most superannuation funds are still ahead of their targets, the returns over the last year are a timely reminder of the risk in some of these strategies.

As a general rule, these funds are heavily invested in traditional assets like shares, cash, and fixed income assets.

These are the very assets exposed to both a downturn in the economy and higher inflation rates. The record run that the share market had been on in the aftermath of the COVID-19 crash in early 2020 up until the end of last year only adds to the risk in markets today.

Given this backdrop, it’s no surprise to see that every day, more and more Australians are choosing to manage their superannuation through a self-managed superannuation fund (SMSF).

While clearly not for everyone, the added flexibility that a SMSF allows can be of great benefit to investors. This is because it allows them to invest in a wider range of assets, which of course includes pink diamonds.

We would not be surprised to see this trend continue for some time, given pink diamond performance looks well placed to continue outperforming traditional assets, and given fears over recessions and higher inflation are unlikely to abate any time soon. 

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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