It’s hard to believe that it’s already May.
The year has absolutely flown past to date, no doubt driven in part by how strong the demand for pink diamonds has been, with Australian Diamond Portfolio welcoming many new clients in 2022 so far.
While pink diamond investors have enjoyed the relative stability and continued price growth that have become hallmarks of this asset class for the past 15 plus years, it’s been a far more tumultuous year for investors in other asset classes.
Share markets are down, both locally and internationally, while bonds, which are normally seen as safe havens, are having one of their worst years on record. Cryptocurrency prices have also crashed, with Bitcoin down more than 20% so far in 2022, while inflation continues to fester.
On top of all this, investors are now having to deal with higher interest rates, something that they haven’t seen in years.
We look at this in detail below, looking at the challenges they pose and why they probably won’t go as high as markets currently expect.
Most importantly, we look at why rising interest rates are no challenge to the pink diamond market, and indeed may be a catalyst to send pink diamond prices even higher in the years to come.
How high will interest rates go
Yesterday, the Reserve Bank of Australia (RBA) made a widely anticipated increase in local interest rates, the first time in 11 years that interest rates have moved up. While most market commentators thought the RBA would only increase rates by 0.15%, they instead delivered an increase of 0.25%, with the local cash rate now sitting at 0.35%.
While there has been plenty of commentary about the move, and how soon they’ll deliver their next rate hike, and whether that will be another 0.25% hike or maybe even a 0.50% hike, the reality is that the market has already ‘priced in’ an extreme level of tightening between now and the end of September next year.
This can be seen in the chart below, which comes from the ASX, and shows market expectations of where interest rates will be sitting in every month between now and September 2023.
ASX 30 Day Interbank Cash Rate Futures Implied Yield Curve
As at market close on 3rd May 2022
As you can see the pink columns (which represent the market expectation for where rates will be in any given month) are constantly rising, with the market currently expecting the cash rate to sit at roughly 3.50% about a year from now.
That’s an increase of more than 3% from where interest rates sit today.
We think that there is almost no chance that this will happen and would note that in the aftermath of the Global Financial Crisis which hit between 2008 and 2010, the RBA was only able to increase the cash rate by 1.75% (from 3% in September 2009 to 4.75% in November 2010) in total.
Back then the global economy was rebounding, China was buying commodities at a rapid pace, the Australian dollar was flying, and inflation was non-existent.
Today, the situation is far more fragile, with Australian households, and indeed the Australian government far more indebted as compared to just over 10 years ago.
For this reason, while we expect interest rates to continue to increase between now and the end of the year, we have no confidence they’ll get anywhere near 3.5% in the next twelve months, as the market currently expects.
Pink diamonds to ‘ignore’ rate hikes!
Some investors may think that higher interest rates will be bad news for pink diamonds, given the diamonds themselves don’t generate an income like money in the bank can.
While there is a theoretical logic to this argument, history actually shows that rising interest rate environments often coincide with periods where hard assets perform very well, both in absolute, and especially in relative terms good for hard assets.
And the reason for that is it’s not just about what happens to interest rates, but other asset markets, and inflation as well.
To that end, it’s important to remember that inflation is currently running at more than 5% per annum in Australia, so anyone sitting in cash or term deposits is still ‘going backwards’ in real terms.
Investors should expect these elevated levels of inflation to remain for some time to come, given the many inflationary tailwinds in play, including the continued conflict in the Ukraine, the ongoing efforts to minimise the spread of COVID (especially in China, which is hugely important to Australia), and the fact that monetary policy is still very loose despite the interest rate hike we saw yesterday.
As a result, traditional safe havens like cash and government bonds are likely to remain losers in real terms, while any moves to increase interest rates risk slowing if not outright killing both the property market (which has already begun to weaken), and the share market.
Given this backdrop, pink diamonds can still be expected to outperform in the period ahead, as they remain one of the best assets to both protect and increase wealth through these difficult investing times.
As such, the pink diamond market will largely ‘ignore’ the rate hike we saw yesterday, with supply constrained, while demand, and prices, continue to rise.
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.