27 Jul

Time to go overweight on pink diamonds

The new financial year is off to an interesting start for investors, with central banks hitting pause (for now) on interest rate hikes, in Australia at least, while there are signs inflation will continue to ease in the short-term.

Despite that news, which would on the surface appear to be good for the economy and for investors, we are seeing renewed spikes in volatility, with uncertainty again creeping into the Australian housing market.

That uncertainty, and the desire to find alternative assets which can protect and grow wealth in all parts of the market cycle, has always been a major factor driving investment demand for pink diamonds.

When you couple that pure investment driver with the desire of people the world over who wish to own and display rare tangible items of exquisite beauty, you have a potent mix for higher pink diamond demand, and higher pink diamond prices.

This week we explore another factor which suggests now is a great time to be looking at incorporating these assets into a well-diversified portfolio.

Underweight vs Overweight

In the investment world, portfolio managers and institutional investors often talk about being overweight a certain asset class, and underweight others.

But what does this mean, and what is the relevance to pink diamonds?

In reality, diversified institutional investors typically have some exposure to most asset classes at all times.

By this we mean that they will almost never hold zero exposure to the share market, or the bond market, or property or cash in the bank, but will instead increase or decrease their exposure based on their view of market conditions. They will also typically have target (or standard) allocations to all major asset classes.

For example, a target allocation for a simple diversified portfolio might be 60% equities, 30% bonds and 10% cash.

If this was the target allocation for a hypothetical portfolio, but at a point in time the manager had 65% of their money in equities and only 25% in bonds, plus 10% in cash, they would say they are overweight equities, underweight bonds, and neutral when it comes to cash.

This is highly relevant for pink diamonds today, because a recent survey of institutional investors conducted by Bank of America Merrill Lynch has found that institutional portfolio managers are heavily underweight commodities.

Indeed, as per the chart below, these institutional investors are now more underweight commodities today than at any point since May 2020, which is just over three years ago.

That of course more or less aligns perfectly with the onset of  the COVID-19 pandemic, and the economic lockdowns as well as fiscal and monetary stimulus that combined to drive the inflationary spike we’ve all been dealing with ever since.

FMS investors most UW commodities since May ’20
Net % FMS investors saying they are OW commodities

Chart of FMS investors most underweight commodities since May '20

Source: BofA Global Fund Manager Survey, BofA Global Research.

That alone is a positive sign for commodities and hard assets, which of course includes pink diamonds, for the simple reason that peaks and troughs in ratios like the one above often occur at pivot points in markets.

A good example, which is also illustrated on the chart above would be February 2011, when investors were heavily overweight commodities. That aligns almost perfectly with a time that commodities were very expensive, and about to begin a multi-year bear market.

The market positioning couldn’t be more different today, which suggests that the next few years may be very rewarding for commodity investors.

And given higher commodity prices typically lead to higher inflation, assets that benefit from high inflation, including pink diamonds, may benefit most of all.

It’s not just about commodity allocations

While charts like the one in the section above are a good reason to be optimistic on the outlook for hard assets like pink diamonds, they aren’t the only reason we remain so bullish.

Scarcity remains a huge factor, as does tangibility, and genuine beauty. These three factors don’t change week to week when it comes to pink diamonds (which is part of the reason we typically only mention them in passing), but that doesn’t mean they don’t matter.

They absolutely do, with pink diamonds to benefit for years to come given these tailwinds.

Another factor that will drive pink diamond demand is the risk that continues to build in more traditional assets. This week we see further evidence of this through the chart below, shared by @CallumThomas of @TopDownCharts.

As Callum himself noted, “speculation is so back: This indicator tracks the popularity of leveraged long US equity ETFs relative to leveraged short (or inverse) ETFs. You can see clearly both the euphoric frenzy that took hold in 2021, as well as the subsequent collapse in bullish speculation… and now, after a year of slumber, bullish speculation is back in style.”

Leveraged ETF Trading – Long vs Short

Chart of Leveraged ETF Trading - Long vs Short

Source: Topdown Charts, Refinitiv Datastream.

Clearly, more and more people are leveraging up, hoping they’ll get rich playing the stock market. It has happened many times in the past. It will continue to happen in the future.

But if history is any guide, periods of excess speculation (which we are basically in now) always end badly. This will almost certainly see investors turn to alternative assets as a form of protection and growth in the period ahead, when these more traditional assets hit their next bout of turbulence, as they inevitably do.

For reasons we’ve made clear many times in the past, we see no other asset class that will benefit to the same extent that pink diamonds will as these events and trends unfold.

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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