08 Dec

What were you thinking?

It’s now barely two weeks until Christmas 2021 is here.

We for one are looking forward to relaxing with family over the holiday break, enjoying the opportunity to ignore, for a couple of weeks at least, the COVID-19 developments that continue to plague financial markets, interrupt travel plans and create a heightened sense of uncertainty as next year approaches.

With no pink diamond specific news to share this week, we wanted to touch on three noteworthy investment subjects, all of which contribute to the rationale for owning pink diamonds today.

Beware the fake safe havens

The biggest news of the last week was the enormous crash in cryptocurrency prices, which fell in some cases by more than 20% in just a couple of trading days.

Bitcoin, the largest and most widely known of all the cryptocurrencies, at one point fell toward USD $40,000 per coin, down almost 40% from the highs seen in early November.

Others were even harder hit, with the total value of the entire cryptocurrency ecosystem shedding over USD $200 billion in the space of 48 hours.

While cryptocurrencies have always been volatile, the fact this is still happening despite Bitcoin supposedly going mainstream, highlights just how risky an asset class cryptocurrencies remain.

They might be marketed as safe havens, but so far at least, cryptocurrencies have proved anything but.

Furthermore, unlike pink diamonds (which actually do have a track record as safe havens in periods of equity volatility or high inflation), with cryptocurrencies, you don’t physically own anything, just records in a digital ledger.

It’s not just that the prices can go up and down in wild fashion.

It’s that as an investor, you have no guarantee the blockchains on which they are built will last at all.

Pink diamonds are different. They are tangible, and they will endure.

All eyes on inflation

The second subject to talk about is inflation, which has been soaring in the United States and other parts of the developed world for most of the year.

In October, the headline rate of inflation in the USA was 6.2% for the year, a number many analysts think will go higher, not lower, in the months ahead.

Worryingly, these higher rates of inflation are becoming more evenly spread across the economy, with core inflation rates and average inflation rates also now both above 4% per annum, as the chart below highlights.

Median Consumer Price Index

Chart of Median Consumer Price Index

Source: Bureau of Labor Statistics, Federal Reserve Bank of Cleveland, Haver Analytics.

If inflation was to average 4% per annum over the next decade then investors in zero yielding bank accounts would see the value of their cash lose 50% of its value between now and 2030.

Given the inflationary trends already on display today, and the historical precedent that shows it’s normal to see higher inflation during periods of soaring government debt and money printing, this is probably issue number one for investors to keep in mind as we head into next year.

From our perspective, it’s also one of the main reasons we are glad we hold hard assets like pink diamonds in our portfolio.

What are investors thinking

This brings us to the final newsworthy story of the week to share.

The chart below shows the percentage of the companies that are currently trading at more than 10 times their sales.

To explain what this means by using an example, if a company generated $10 per share a year in sales (not profit mind you, just sales) and was trading at $150 per share, then it would be trading at 15 times sales.

Percentage of All Stocks > 10x Price to Sales

Chart of Percentage of All Stocks > 10x Price to Sales

Source: Kailash Capital, LLC.

As the chart makes clear, this number is currently at all-time highs, with a substantially larger share of companies trading at more than 10 times sales today compared even to the late 1990s/early 2000s’, which was the height of the infamous NASDAQ boom.

To conceptualise how crazy this scenario is, consider the famous quote below, which comes from Scott McNealy. He was the CEO of Sun Microsystems, one of the market darlings of the NASDAQ boom just over 20 years ago, with his company at one-point trading at 10 times sales.

In 2002, he had the below to say on the investor overexurbance on display at the time, using his own stock as way to tell the story.

“At 10 times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends. That assumes I can get that by my shareholders. That assumes I have zero cost of goods sold, which is very hard for a computer company. That assumes zero expenses, which is really hard with 39,000 employees. That assumes I pay no taxes, which is very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal. And that assumes with zero R&D for the next 10 years, I can maintain the current revenue run rate. Now, having done that, would any of you like to buy my stock at $64? Do you realize how ridiculous those basic assumptions are? You don’t need any transparency. You don’t need any footnotes. What were you thinking?”

This kind of mania rarely, if ever, works out well for investors, with charts like this best seen as a clear warning sign that equity markets are due for a major correction, which could come anytime.

We don’t know what investors are thinking for today.

From our perspective, we certainly don’t want to have too much exposure to broader stock markets today and are much more comfortable in pink diamonds.

Next week is our last report for the year!

Next week will be our final market update for 2021, with the team at Australian Diamond Portfolio set to take a well-deserved break with family and friends, before we charge back into next year.

As a reminder, we will be closed from 23 December to 10 January, though will be checking emails intermittently over this time period.

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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