After a few updates that have predominantly concentrated on diamond specific stories in the media, we are changing track this week to look at the re-emergence of Stagflation, an economic phenomenon last seen in the 1970s.
Stagflation of course refers to a phenomenon of lower economic growth and employment, combined with rapid increases in consumer prices and is generally considered the most challenging part of the economic cycle for society to go through.
It also tends to create a very difficult environment for investors, though as you’ll see, Stagflation is also likely to prove very supportive for investors in hard assets, including pink diamonds.
Read on below for more.
The return of Stagflation
The below headline from a 10th September CNBC article, quoting a Bank of America economist highlights the fact that there is an increased focus on the potential for Stagflation to rear its ugly head in the US and global economy.
It’s not just Bank of America either, with the following headlines appearing in mainstream publications in the last few weeks:
- USA Today: Are we at risk of Stagflation as prices rise and growth slows.
- Mauldin Economics: The Return of Stagflation
- Bloomberg: What’s happening in the world economy: Stagflation
- Livewire Markets: Stagflation risk for stimulus addicted markets
- Project Syndicate: The Stagflation threat is real
While Stagflation doesn’t occur very often, all the moving parts required to see it remerge are in place today.
Firstly, we have, and will continue to have very loose monetary policy, with central banks printing record or near records sums of money and keeping interest rates suppressed.
Secondly, we’ve given the economy an enormous economic jolt through unprecedented government spending, the benefit of which is now wearing off.
Thirdly, we’ve still got major supply chain issues around the world, which are adding to costs for businesses, which they have to pass onto customers.
Finally, we have continued confusion regarding the way forward as regards COVID-19, and whether or not workers (and customers) need to be vaccinated in order to perform their jobs or go out for a meal or to a sports game or the theatre.
Conservatively, this likely places up to 20% of adults somewhat in limbo as regards their ability to produce (as workers) or consume (as customers) in the economy going forward.
Add all of these factors together, and it’s clear that in the coming years we could see growth rates fall well short of what policymakers want to see happen, while inflation rates could remain firmly above the 3-4% range on an annual basis.
As the USA Today article highlighted, from an economic standpoint, Stagflation is a ‘worst of all worlds’ environment, but we do ourselves no favours in pretending it can’t or won’t happen.
This is particularly relevant in the context of our investments, as there are a few key things to keep in mind as regards Stagflation and its likely impact on one’s portfolio.
- Cash in the bank will continue to be a loser in real terms, as higher rates of inflation eat away at the purchasing power of the money investors have sitting in easily accessible bank accounts or in term deposits.
- Traditional safe havens like government bonds will also suffer, as the coupon payments, and the principal that is eventually repaid to investors loses its real purchasing power over time. Yields often tend to rise too, generating losses for bond investors who might otherwise wish to sell these loss-making investments.
- Equity markets tend to suffer as a Stagflation environment is typically one that is fairly low-growth, and one where the real incomes that households earn goes backwards. This limits those households in their ability to consume, which in turn negatively impacts the sales, and therefore profits companies can make.
Troubling as this outlook for mainstream assets is during an environment of Stagflation, there is a solution at hand, and that is investing in hard assets. For history tells us very clearly that during periods of Stagflation, investments in commodities tend to perform very well.
This should come as no surprise, as commodities are after all real assets, which can be trusted to hold their value over the long-run.
It makes sense that in an environment where other assets are performing poorly, economic growth is slow, and inflation is rising, investors gravitate toward such assets, as preserving value becomes more important than ever.
The fact that commodities are already so cheap relative to equities (see chart below for evidence of this) only reinforces why so many astute investors are turning to hard assets today.
S&P Commodity Index vs S&P 500
Pink diamonds, with their genuine scarcity, and multi-faceted sources of demand stand to benefit from this trend as much if not more than any other commodity as this Stagflationary wave crashes over the economy and financial markets in the years ahead.
A tailwind for pink diamonds!
There are multiple reasons why we think pink diamond prices will soar this decade, from curtailed supply given last year’s closure of the Argyle Diamond mine, while on the demand side, their astonishing beauty, and the very strong returns they’ve generated over the long-term will always see them well supported.
Given this backdrop, the re-emergence of Stagflation as an economic phenomenon only adds to the tailwinds supporting this unique asset class and helps explain why the demand for pink diamonds that we are seeing at Australian Diamond Portfolio is as strong as it’s ever been.
It’s a trend we expect to remain in place going forward.
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.