23 Sep

Pink diamonds will pay dividends as investors diversify

The uptick in financial market volatility that we have seen in September continued in the last week, with global financial markets continuing their recent pull-back.

Whilst no one can be sure, we wouldn’t be surprised to see an extended period of uncertainty, with the US election only a few weeks away, and the threat of COVID-19 seeming to re-emerge in parts of Europe.

After our last couple of articles which have looked at the 2020 Argyle Tender, and some of the specifics of the pink diamond market itself, this market update looks at some of the economic and investment factors that continue to encourage astute investors to consider hard assets in the first place.

What to do with all those dividends

This week we came across an interesting article which highlighted the decision investors will have to make on the circa AUD $9 billion in dividends that are due to paid by Australian listed companies in the coming two weeks.

Shareholders in BHP, CBA, Telstra, ANZ, Coles, AGL, the ASX itself, Medibank, Santos and a host of others are all due to receive a cash boost, even if dividends across the market as a whole have been cut meaningfully in response to the COVID-19 induced economic slowdown.

In essence, investors have three choices in terms of what to do with this money:

  • Take the cash and save or spend it
  • Reinvest in more shares in the company
  • Use the money to invest in other assets

From our perspective, we think many investors will be tempted to utilise this cashflow to look for alternative investment opportunities, in the hope of diversifying their portfolios and reducing overall equity market risk.

There are multiple reasons for this, including the fact that cash-flows from businesses in the form of dividend payments are highly uncertain today. Many economic commentators are now stating that total economic activity won’t return to its 2019 levels until 2022-2023 at this point.

Even this might be optimistic, as it relies on either no second or third wave of COVID-19 hitting globally, and/or the development of a vaccine, neither of which can be relied on.

Given this outlook, it is only natural that listed companies either reduce and in some cases cancel dividends, as they seek to bolster their balance sheets and ride out this economic storm.

Indeed, we are already seeing companies start to think this way (prioritising survival over growth), with the outlook for business investment incredibly poor.

As evidence of this, consider the chart below. It comes from a Deloitte CFO survey, and highlights the share of companies that think they will have more, less or the same amount of debt in June 2021 vs 2020.

Expected level of funded debt level in June 2021 compare to 2020
As you can see, more than 60% of companies expect to have either less debt, or the same level of debt as they do today.

This is despite record low nominal interest rates, and monetary and fiscal stimulus that is running at record highs.

Clearly, the business community is not prepared to invest in itself. Why should investors put more money into businesses?

We think it’s far more likely that a growing number of investors will instead use dividend payments, as well as the cash holdings in their portfolio that are earning less than nothing after inflation to buy hard assets.

Hard assets, which include pink diamonds, are the asset class that can best be relied on to deliver capital stability, and long-term outperformance, irrespective of developments in equity markets.

Other tailwinds for pink diamonds

A desire to diversify one’s portfolio isn’t the only tailwind supporting pink diamonds, as regular readers of our reports will know.

On the supply side, obviously the closure of the Argyle Diamond Mine will help create additional scarcity, given 90% of the world’s supply of coloured diamonds comes from this one mine.

Negative real interest rates on cash and bonds all across the developed world, plus the commitment of central banks to keep rates low for years to come (The Federal Reserve has said it thinks it won’t raise interest rates until at least 2023 at this stage, with other countries like Australia facing a similar dilemma) will obviously help fuel the demand side of the equation.

Investors are naturally going to look for alternatives rather than guaranteeing a loss of their purchasing power by keeping their money in the bank, with the long-term returns of pink diamonds (more than 10% per annum across the last 15 years), comparing very favourably in the current environment.

Combined, these supply side and demand side dynamics will see astute investors continue to turn to pink diamonds, looking to secure their exposure to this unique and dynamic asset class before prices naturally rebalance higher.

This is something we’ve seen first-hand at Australian Diamond Portfolio over the last few years and is a trend we expect to continue for much of this decade.

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.


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