12 Aug

The Calm Before the Storm

Financial markets have rallied this week, despite the continued spread of COVID-19 and the uncertainty caused by it, with the ASX 200 up by more than 3.5% in August so far.

The rally is not so much a reflection of rising consumer confidence, as this continues to decline, and instead is being driven by expectations that central banks will be forced to increase their policy support for financial markets.

The real economy itself continues to deteriorate, something we expect to see reflected in updated unemployment figures which are due out in Australia this week.

Troubling as the trends in unemployment and other indicators like GDP are, we think the headline numbers are hiding an even more alarming economic reality.

It is our belief that this reality will eventually come to light, helping fuel an investor rush toward safe haven assets like pink diamonds.

The calm before the storm

Whilst nearly everyone is well aware that COVID-19 is having a hugely negative impact on the economy, we don’t think investors are paying enough attention to how much worse things would be were it not for the governments unprecedented, and more importantly, unsustainable levels of support.

In many ways, whilst we might be in the thick of things when it comes to managing the threat of the virus itself, it feels like we are in a period of calm when it comes to the economy itself.

This calm can be seen in many places.

Retail sales (in particular online) are being boosted by government support provided via Jobkeeper and Jobseeker payments to individuals, as well as lending facilities to support small and medium size enterprises etc, with sales figures far more robust than you’d expect to see in the middle of a once in century pandemic and economic contraction.

Further evidence of it can be seen in the number of personal insolvencies in Australia, which as per the chart below, has fallen to a near 25 year low.


New personal insolvencies: JobKeeper rescue?

New personal insolvencies: JobKeeper rescue?

Source: AFSA, CommSec

How can that happen in the middle of a pandemic that has in many ways shut the economy down? If anything, you’d expect that insolvencies would have risen, and indeed they can be expected to in the months and years ahead.

The only thing that has prevented it is government spending, plus rules allowing people to access their super (this has topped AUD $30 billion), bank lending deferrals (more than AUD $250 billion), and moratoriums on evicting people who can’t pay their rent.

It is totally understandable why this support has been deployed, but that doesn’t change the reality that it is simply not sustainable in the long-run.

Sooner or later people need to start paying their mortgage, or their small business loan, or the bank needs to write it off.

The government itself is planning on rapidly reducing stimulus, with estimates from the Grattan Institute suggesting income support in Australia will drop from roughly $18 billion a month now to just $3 billion a month by November. That will put a huge hole in the economy, and one that the private sector will be in no position to fill.

Even if the government decided to extend their support, it’s still money they’ll need to borrow from households.

The only other solution is to get the Reserve Bank of Australia to print the money. We have no doubt printing the money is what Modern Monetary Theory advocates would suggest, but even that would create problems all of their own, which we wrote about last week.

Make no mistake – a storm is coming.

Investment implications

An expected uptick in insolvencies, the likely rise in the number of people who can’t pay their mortgage, and higher unemployment in the coming years will have significant consequences on people’s wealth, with most traditional investments likely to suffer.

Looking ahead we think it’s highly likely that:

  • Property prices continue to head lower in the years ahead, with many forecasters now seeing declines of 20% (with larger falls in Sydney and Melbourne) as a base case scenario.
  • Large parts of the share market will struggle, especially in Australia, where banking stocks (which are highly exposed to our property market) make up such a large portion of our market.
  • The cash rate, which is already just 0.25%, could potentially go below zero, further punishing savers who are already earning less than the rate of inflation on the money they have in the bank.
  • Bonds, which make up a large portion of the average Australian’s superannuation fund, will also continue to lose real value, with some bonds set to deliver negative real returns for the next thirty years.
  • The Australian dollar will be under increasing pressure, with some forecasters seeing it at least re-testing the lows of March 2020, when it fell to USD $0.55, in the months ahead.

Most investors remain oblivious to these threats, with an investment portfolio built on these assets essentially a ‘hope for the best’ approach.

We personally don’t think that’s a prudent way to approach things, nor is it likely to be very profitable, with alternative assets like pink diamonds far more likely to thrive during this unprecedented times.

Whether it be diversification, inflation protection or outright capital gain, pink diamonds offer the potential to deliver all of these outcomes in the years ahead, with the rotation from risky financial assets to truly scarce hard assets likely to be a dominant investment theme 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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