04 Dec

The Case for Pink Diamonds Strengthened in 2019

In this final update for 2019, we are going to review a handful of key points which we think clients of Australian Diamond Portfolio should keep front of mind as they work out how best to structure their investments as we head into the next decade.

The report will review:

  • The performance of pink diamonds in 2019
  • How far equities could fall in the next correction
  • Risks in defensive assets like cash and bonds
  • Why Australia will continue to struggle economically

As you will discover from reading this report, the 2020’s promise to be a very rewarding period for pink diamond investment, with this unique asset class set to benefit from multiple tailwinds.

These include the pending closure of the Argyle Diamond Mine, as well as an economic and financial market environment that will continue to push astute investors toward hard tangible assets.

We trust you will enjoy the report, and encourage you to share it with friends, family and colleagues that you think would benefit from reading it.

 

2019 - Year in review

Image © Rio Tinto 2019

Diamond Demand Strong as Argyle set to Close

Pink diamond demand was strong throughout 2019, with Australian Diamond Portfolio having its busiest year ever. The increase in demand that we saw in our business personally was in line with global trends, best evidenced through the strength of this year’s Argyle Tender.

Titled “The Quest for the Absolute”, this year’s Argyle Tender saw a more than double-digit increase in bids relative to last year, as astute investors worldwide look to diversify and build wealth through this unique asset class.

Performance for pink diamonds themselves was positive, with the market rising by 1% in the twelve months to end September, according to the Fancy Colour Research Foundation (FCRF), though this number in our view understates the true strength of the market, with all our suppliers seeing substantially larger increases in prices throughout 2019.

Note that the modest gain seen in USD terms was boosted for Australian investors who also benefitted from the 3.5% decline in the value of the AUD over the first 11 months of 2019.

Long-term returns for pink diamonds are still incredibly strong, as you can see in the chart below, which shows the 10-15% per annum increase in prices for various pink diamond categories since 2005, with pink diamonds from the Argyle Tender rising by 500% over the last two decades.

 

Growth Across Investment Pink Diamond Categories

Pink Diamond Appreciation

Source: Fancy Colour Research Foundation (FCRF)

 

Importantly, as the FCRF data makes clear, pink diamonds comfortably outperformed other categories of coloured diamonds, including blue diamonds and especially yellow coloured diamonds, which fell by 1.5% in Q3 2019 and by almost 5% over the twelve months to end September 2019.

This performance discrepancy, and vastly different supply/demand profiles highlight why it’s important to work with experts when investing in diamonds, and also reinforces why Australian Diamond Portfolio almost exclusively focuses on pink diamonds when working with our clients.

Market attention this year was quite rightly focused on the closure of the Argyle Diamond Mine, which Rio Tinto have confirmed will cease production in 2020. The closure of the mine, which will close a glorious chapter in Australian mining history, is set to be a major catalyst for the pink diamond market in the next decade, with over 90% of the annual global production of pink diamonds coming from Argyle.

As we discussed in our widely read special report: “Argyle Mine Closure – What Does This Mean”, the closure of the mine can only be a good thing for the price of pink diamonds, with this unique asset class becoming even more desirable in years to come.

How Far can Equities Fall?

Before we get into the risks in equity markets, it is worth acknowledging that 2019 is on track to be another standout year for equity markets, with the S&P500 up nearly 25% in the 11 months to end November, whilst the local sharemarket has also performed strongly, rising by 20%.

This strength is indeed one of the reasons diamond returns have been more subdued than their historical averages, as investors still feel comfortable chasing risky assets like shares, with many only looking to diversify after markets start to fall meaningfully.

Whilst we can’t be sure when the bull market in equities will end, that it will end is a certainty, with no market going up forever.

The chart below, which comes from a great report from Schroders, helps us quantify how big the correction might be, based on historical bull and bear markets in the United States since the early 1960s.

markets, with the S&P500 up nearly 25% in the 11 months to end November, whilst the local sharemarket has also performed strongly, rising by 20%.

This strength is indeed one of the reasons diamond returns have been more subdued than their historical averages, as investors still feel comfortable chasing risk assets like shares, with many only looking to diversify after markets start to fall meaningfully.

Whilst we can’t be sure when the bull market in equities will end, that it will end is a certainty, with no market going up forever.

The chart below, which comes from a great report from Schroders, helps us quantify how big the correction might be, based on historical bull and bear markets in the United States since the early 1960s.

 

Bear Markets in the United States

Bear markets

Source: Schroders

 

Based on our calculations from the above chart, the average decline in each bear market seen above was 41%. A crash in equity markets of such magnitude alone will be enough to encourage investors to diversify into hard assets, though in our opinion, the next bear market in stocks may well exceed 41%.

We say that for a few key reasons, including the fact that the current bull market in equities is the strongest (+405% vs an average of 170% for those preceding it), and the longest (127 months vs 63 months for those preceding it) of all the bull markets seen since the 1960s by some margin.

It’s also one that has required unprecedented stimulus, with trillions of dollars of printed money and negative real interest rates seen all around the developed world in the last decade.

Given markets by their very nature eventually shake off prior excesses, we wouldn’t be surprised if the greatest bull market of the last 60 years is followed by the greatest bear market.

We can’t be certain that it will start next month or next year, but we want to be prepared nonetheless. It is a key factor driving our own personal decision to invest in pink diamonds, and one that we discuss with clients at Australian Diamond Portfolio on a regular basis.

Risk in Bond Markets and in Cash

If you are worried about stock market risk (as we think investors should be) then conventional portfolio management theory will tell you that cash and bonds are the ‘safe’ assets that investors should own in their portfolios, as they are the least volatile.

Whilst there is some truth to this, it’s important to remember that volatility is only one risk investors need to be conscious of, with many other factors like inflation risk, credit risk, and valuation risk arguably even more important.

More importantly, whilst cash and bonds aren’t volatile, the yield you can earn on them around much of the developed world, including in Australia, is often negative in real terms today, given rates are at all-time lows.

In our many discussions with clients at Australian Diamond Portfolio, we are yet to meet a person who describes an investment that is guaranteed to lose money as a low risk investment.

The risk is particularly pronounced in the bond market right now, especially given inflows into investment grade bonds in 2019 are on track to hit their highest levels in years, indicative of the over-enthusiasm of mainstream investors to chase this asset class, even though the risk/return outlook has arguably never been more unfavourable than it is today.

This is something that Callum Thomas of TopDown charts has warned about, stating in late November; “What if I told you that the assets most investors look to for safety and capital preservation could actually be the biggest source of risk in portfolios right now?” Thomas went on to say that; “The traditionally defensive assets are looking very richly priced” and that; “defensive assets could become a source of risk rather than a hedge against risk.” 

Wise words indeed, and it’s why astute investors, rather than chasing supposedly low risk investments, or piling into any security just because it offers a positive yield are instead choosing to protect and grow capital through investment in hard assets.

As we move into 2020, expect this trend, which will be very supportive of pink diamond prices, to not only continue, but to strengthen.

Australia is in trouble

Regular readers of In the Loupe will know that our negative outlook for the Australian dollar is one of the reasons we are particularly bullish on the outlook for pink diamonds for local investors, with that negative AUD outlook driven by deteriorating conditions in the local economy.

For evidence of this, one need look no further than the three interest rate cuts delivered by the Reserve Bank of Australia (RBA) this year, which has brought the local cash rate down to just 0.75%.

It was only twelve months ago that the RBA and most economists were suggesting cash rates would be RISING this year, but instead they’ve halved, with more interest rate cuts and quantitative easing (QE) or money printing likely by the second half of 2020 at the latest.

Why is this happening?

The answer is as simple as it is troubling, and that is the Australian economy is experiencing a per capita recession, where the total value of economic output per head of population is falling, with no sign of this changing any time soon.

Most forecasters, who are paid to be optimistic rather than realistic, will tell you the wheel will soon turn, but we’ve been hearing this for years, including from the RBA, who are constantly forecasting higher growth year after year after year, even though it never eventuates.

The following chart makes that clear, showing the progression of RBA GDP forecasts from the first forecast for the year through to the actual outcome. Note how the lines almost constantly fall, indicating actual growth generated by the economy eventually falls well short of original forecasts.

 

RBA Real GDP forecast*

GDP forecasting

*Dates based on RBA SoMP release (final date is actual). Latest SoMP data is Nov 2019.

 

Given Australian household debt to income recently topped 200% (a new record), wage growth is still near record lows, unemployment and underemployment are still major problems, inflation for essential items is rising and businesses are cutting back on investment plans, there is zero reason to expect the growth story to get better in 2020, or indeed for some years to come.

If anything, you can likely expect the economy to continue to deteriorate, with the building industry and manufacturing set to struggle, with the huge oversupply of apartments built on the East Coast of Australia likely to limit residential construction for the next few years.

The troubling outlook is perhaps best captured in the following chart, which highlights the fact that Australian consumer confidence is now at a multi-year low, whilst a recent consumer sentiment tracker from finder.com found that 50% of Australians think a recession is imminent.

 

Confidence at multi-year low

Confidence

Source: ANZ-Roy Morgan

 

Given that backdrop, and its implications for interest rates (which look like they will remain negative in real terms for the entire 2020s at a minimum) it’s imperative that investors diversify, protect and grow their wealth with hard tangible assets.

These hard tangible assets, including pink diamonds, are best suited to deliver positive real returns in the decade ahead, with the closure of the Argyle Mine, and the massive reduction in the supply of pink diamonds that we will see from the end of next year adding a unique element that investors can benefit from.

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.

We’d also like to send you a big thank you for your loyal readership across the year, and the many questions and feedback we get from these publications. We look forward to writing again in 2020.

In the meantime, we wish you and your loved ones a very merry holiday season and a Happy New Year.

 

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