06 Nov

Three tailwinds to spur diamond demand

In this week’s article, we look at three factors we expect will support the pink diamond market in years to come.

We also look at why investors and would-be investors in pink diamonds will need to be patient, with the two-speed market (which we referred to in our most recent update a few weeks ago) likely to continue for a while.

Interest rates, inflation and currency markets

For many Australians with debt, especially those under the age of 35, the last two years must have felt very strange. For the first time in their adult lives, interest rates have gone up.

Indeed, not only have they gone up, but they’ve risen at one of the fastest rates that we’ve seen in decades, with the Reserve Bank of Australia (RBA), hiking rates from just 0.10% in May of 2022 to 4.10% by June 2023, a time period of just over one year.

And while they’ve been on hold since June, there is talk that there will be at least one more rate hike before Christmas this year, or in the first quarter of 2024.

The speed at which rates have risen, and the level of debt that Australian households now hold means that mortgage repayments in this country, as a share of household income, are at record highs.

In short, these higher rates are causing a lot of pain in the economy, which is exactly why they’ll have to start coming down at some point, with it growing increasingly likely that rates will begin to decrease by middle to late 2024.

This would be bullish for pink diamonds if they do, as it will make holding cash in the bank less attractive for investors and savers, especially if inflation remains uncomfortably high.

On that note, there is a very good chance that inflation will remain well above 2%-3% per annum (the range policymakers tend to target), with commodity prices, a key input into inflation likely to remain high.

Part of the reason for this is that the last ten years have seen a huge underinvestment in bringing new supply of commodities to the market. This can be seen in the chart below, sourced here from TopDown Charts, which plots commodity investment on a rolling basis dating back to early 1980s.

Commodity Capex: long period of underinvestment

Source: Topdown Charts, Refinitiv Datastream.

As the chart highlights, back in say 2011-2013, investment in most parts of the commodity universe was very high. That was right before prices crashed, with the last decade seeing very little investment.

This means that it’s going to be very hard for supply of commodities to rise, at least for the foreseeable future. In turn, it will put upward pressure on inflation, which combined with lower interest rates helps to make the case for hard assets like pink diamonds all the more compelling.

Last but not least there are currency markets, and the outlook for the Australian dollar.

Given the specific risks Australia faces, from a slowdown in China to record high house prices and personal debt levels, it would not surprise us to see the Australian economy struggle enormously in the next few years. Indeed, we are already in a recession on a per capita basis. With real wages going backwards, household confidence very low, and the rising risk of a global recession, it’s not unlikely to see the Australian dollar fall towards USD $0.50.

This could be a very handy third pillar supporting the pink diamond market for Australian investors, helping to magnify the gains that this unique asset class can offer.

Patience will pay off!

While developments in interest rate markets, inflationary trends and currency fluctuations are all likely to support pink diamond demand, and pink diamond prices over the medium to long-term, two of these factors, interest rates and inflation, are acting to reduce liquidity in the short-term.

This is because higher inflation and higher interest rates are reducing the amount of cash that investors have to deploy into all asset classes, including pink diamonds.

The fact that the stock market (we are referring to the ASX 200 in Australia here) has fallen by about 10% in nominal terms and about 20% in real terms over the last two years is also a short-term hindrance.

This is because the lack of equity market growth means there are fewer investors feeling like they are ‘in the money’ on their stock positions, and therefore fewer investors who are willing to move even a portion of their portfolio to pink diamonds as a niche or alternative asset.

Compare that to late 2020 when interest rates were still basically at zero, inflation hasn’t yet reared its ugly head, stock markets were rallying hard, and pink diamonds were constantly in the news given the Argyle mine had closed.

We say this, for while allocations to pink diamonds will almost certainly pay off for patient long-term investors, we will likely be in a period of reduced liquidity for some time, until more investors realise inflation isn’t going away, interest rates will need to be cut, and volatility isn’t dead in financial markets.

As this plays out, the market will respond again, as it has in the past.

That’s why we are staying the course.

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.


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