29 Aug 2019

Trade Wars Will Drive Diamond Demand

In last week’s “In the Loupe”, we discussed the short period of calm that had descended on financial markets, noting that whilst many investors were no doubt hoping the worst was behind us, we weren’t so sure, and that in our view, things could yet deteriorate in the months ahead.

Fast forward just seven days and it appears we were right to be concerned, with markets badly rattled by an escalation in the trade war between the United States and China.

They say a picture paints a thousand words, and the one below, which coincided with a story about the plunge on the ASX on Monday 26th August, which followed on from strong losses on Wall Street last Friday, captures the mood of the investment community right now.

Trader wipes his eyes as he watches stock prices at the New York Stock Exchange.

Source: News.com.au

What happened?

This time around, the latest escalation in trade tensions between China and the United States started in Beijing, with the Chinese government announcing retaliatory tariffs on $US75 billion of US goods last Friday, as well as reinstating duties on US car exports to China.

The Chinese government stated that these tariffs would be implemented in phases, with some coming into effect next month, whilst the final phase would be implemented in December. China has recently moved to stop purchasing American agricultural products as well.

Unsurprisingly, the move by the Chinese didn’t go down well in Washington. The White House responded almost immediately, with Donald Trump stating that the United States would raise tariffs from 25% to 30% on USD $250 billion worth of Chinese imports by October 1. Trump also said he’d raise tariffs on another $300 billion worth of imports, which are set to come into place in September.

Whilst the tariff tit-for-that is alarming enough, the thing that really jolted markets was President Trump tweeting that he was now ordering American companies to start looking for an alternative to doing business in China.

On top of the Unites States Treasury Department’s decision to label China a “currency manipulator”, this is being seen as a major escalation in the trade war and is helping drive the recent volatility in equity markets, and rising demand for safe haven assets.

What happens Next?

Whilst we don’t pretend to be geopolitical experts – and can’t be certain what the next move from either side will be, we’d note that over the last year or so, every time analysts have claimed we’d soon see a truce between the United States and China, they’ve been wrong, with the relationship between the two continuing to deteriorate.

It reminds us of what happened just over a decade ago when the Global Financial Crisis (GFC) hit. In the year or so leading into the GFC, economists, bankers and politicians kept telling the people that everything was going to be OK.

One of the most high profile examples of this was in early 2008, when Ben Bernanke (pictured below), then Chairman of the United States Federal Reserve famously stated that he didn’t think house prices would fall, or that the United States would have a recession.

The Federal Reserve is not currently forecasting a recession

We all know what happened back then, with the Federal Reserve getting it spectacularly wrong. For this reason, we wouldn’t be surprised if things got worse on the trade front, and in the global economy in the months ahead.

At the very least we think investors need to be prepared for this eventuality and position their assets accordingly.

Why is it Good for Rare Coloured Diamonds?

The escalation in the trade war will help drive rare coloured diamond demand for a number of reasons. The first of those reasons is that the imposition of tariffs will compound fears of a global recession, and/or economic slowdown.

Given stock markets are still close to all-time highs, and have been rising for almost a decade, recession fears alone can be expected to put downward pressure on share markets, or at least cause investors to look for alternatives, of which rare coloured diamonds are one.

Tariffs are also inflationary, in that they increase costs for businesses, which they will try and pass on to consumers. This will obviously negatively impact investors who have money in cash, which is still paying nothing, or next to nothing in real terms all around the developed world, encouraging these investors to look for inflation-protecting tangible assets.

Rare coloured diamonds have a great track record of maintaining their purchasing power over the long-run, so we expect higher inflation to fuel further demand for this asset class.

The final reason the trade war can be expected to drive rare coloured diamond demand is discretion, and people’s desire to hold hard assets outside the financial system.

It’s worth recalling that this trade war is not happening in isolation. It is occurring in a world where interest rates are near zero, and where banking officials and governments are trying to limit people’s ability to use cash, including here in Australia where the government is looking to pass legislation to ban cash transactions above $10,000.

Compounding this is the fact that places like Hong Kong are losing their ‘safe haven’ status, with investors wanting to get money out due to recent tensions there, as the following Wall Street Journal headline attests too.

Hong Kong residents are moving money out as protests escalate

Add all those factors together and it’s easy to see why astute investors will want to move some of their money into rare coloured diamonds.

Not only do they represent tangible wealth (which can’t be printed like currency), but they can be stored outside the banking system, and they can also be easily transported, meaning it will likely be easier and safer to move wealth using diamonds rather than cash in the years to come.

Couple these attributes with the sharp reduction in supply that we will see when the Argyle Mine closes, as well as the strong returns rare pink diamonds have already delivered over the last 15 years, and we feel more confident than ever in the outlook for this asset class.

 

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