Advantage a Critical ‘Knowledge Gap’ in the Market with Lucapa Diamond Company
Mass-scale misunderstanding of economic principles presents an upside opportunity for LOM stock.
Emerging Growth Report on Lucapa Diamond Company Limited (ASX: LOM)
Although the novel coronavirus pandemic represents an onerous headwind for virtually all business sectors, the crisis uniquely and negatively impacted the diamond industry. Indeed, the outbreak of the mysterious SARS-CoV-2 virus was just the latest of a series of setbacks. While we’re still not out of the clouds yet, astute investors will want to keep their eyes on Lucapa Diamond Company Limited (ASX:LOM)(“Lucapa”), a premium quality gemstone specialist attractively positioned for the demand resurgence already underway.
To understand the opportunity in LOM stock, we must first take a step back and note the conditions that led to a severe deflation in the diamond market price. Several months before heading into the pandemic-disrupted year of 2020, the entire supply chain of the precious minerals sector, from upstream to down, suffered a glut of supply and diminishing liquidity.
Mainly, increased supply from the 2 diamond majors combined with new miners coming online over the years, caused the overall industry valuechain to sag. However, starting from March 2019, diamond prices began to dip then slide conspicuously. Still, the industry succeeded in preventing an all-out erosion in market value. Unlike other precious commodity sectors, gemstones pass through several middlemen layers: traders, polishers and cutters. Encompassing the diamond industry’s midstream players, they, together with the producers absorbed much of the price volatility.
Of course, such a situation could not be maintained in perpetuity. Soon enough, the midstream segment suffered a liquidity crisis. Not helping matters were changes in broader social behaviors. According to a Kitco interview with Paul Zimnisky, an independent diamond analyst and consultant, marriage rates ceased to drive diamond demand to the magnitude they did in the past.
Sadly, by January 2020, the diamond market was at a fork in the road, with many experts labeling the situation as a crisis. A few months later, the Covid-19 pandemic would derail most enterprises, plunging gemstone prices into the abyss due to an utter lack of demand as country borders and diamond markets were forced to close. It wasn’t until July 2020 that valuations finally bottomed.
Yet amid this ugliness is where diamonds and specifically Lucapa is poised for a potentially remarkable comeback.
Diamonds Offer a Truly Unique Investment Opportunity
At first, the notion that any industry could bounce back from an all-out assault on its supply chain seems preposterous. Yet it’s not quite as ridiculous as it seems because we’ve already witnessed seemingly bizarre dichotomies in several other sectors.
As a prime example, look at the U.S. real estate market. In several highly desired metropolitan areas, the Covid-19 pandemic fueled a surge in housing prices, breaking multiple records. On the surface, a catastrophic hit to our economy shouldn’t engender a home-buying rush. But this rally didn’t come from regular folks. Instead, the Washington Post reported that the wealthy bought up real estate, taking advantage of the cheap money environment caused by subterranean interest rates.
Also, look at how the major U.S. equity indices jumped in 2020 following a bruising body blow in March. With millions of workers sent home and with the federal government approving an unprecedented stimulus package, money quickly flowed to the investment markets.
It’s really a demand issue. But what separates diamonds from other investment classes is that the rich – we’re talking the ultra-wealthy, the upper echelon of society – have a keen interest in this market. And what distinguishes Lucapa from other diamond miners is its niche portfolio of supreme-quality diamond assets.
To appreciate the uber-affluent demographic’s desire for diamonds, we must recognize a fundamental fact: no two diamonds are the same. According to the GIA, the world’s foremost authority on diamonds, colored stones and pearls, every diamond is unique. Because of this attribute, experts can identify individual stones – similar to fingerprints under a forensic analyst’s watchful eye.
Diamonds are judged on four key characteristics: clarity, color, cut, and carat weight. Further, the vast majority of diamonds have some flaws. From the GIA’s website, “Flawless grade or quality diamonds are very rare—so rare, in fact, that it’s possible to spend a lifetime in the jewelry industry without ever seeing one, and they command top prices.”
Put another way, diamond mining, production and processing isn’t just about the extraction of the product but the quality of it. Obviously, higher quality is rarer and thus presents a superior investment proposition than mediocre or commercial qualities for example. This is where Lucapa intends to separate itself from its rivals or 95% of the diamond industry, bringing to market only the best gemstones available.
It’s not just empty rhetoric. Through its high-value mines in Angola and Lesotho, Lucapa has been selling diamond batches at incredible premiums. According to Lucapa Managing Director Stephen Wetherall:
Since re-opening following the six-month COVID-19 suspension, Mothae has shown its quality with regular recoveries of large and high-value diamonds leading to run-of-mine diamond prices above US$1000 (about A$1300) per carat for the second sale running.
This is more than 75 per cent above the average diamond price budgeted for Mothae in 2021 and the mine is still to accrete its 50 per cent share of profits from the new cutting and polishing partnership arrangement.
Moving forward, the rarity, quality and uniqueness of diamonds makes this sector a compelling alternative investment for the ultra-wealthy. Believe it or not, some evidence suggests that diamonds, not gold, will be the platform of choice to grow your portfolio. That would make LOM stock at its present market pricing one of the deals of a lifetime.
Investment as Both Art and Opportunity
Typically, during periods of uncertainty, investors have clamored to the safety of gold. With a history extending over 5,000 years as money and as a store of wealth, it’s unlikely that the yellow metal – as barbarous as a relic as it may be – will go to zero. Simply, universal demand and desirability prevents such a notion from being realized.
Yet it hasn’t escaped many investors and analysts that gold has not been performing very well. Sure, the yellow metal hit a record in late summer last year but that was also arguably at the height of chaos and uncertainty, which saw rising Covid-19 cases along with severe job losses and heated, sometimes violent demonstrations calling for social justice and equity.
As the temperature in the public discourse gradually subsided and with the coronavirus vaccine rollout demonstrating encouraging results, the fear trade diminished. As it did, the gold price suffered a deflation. At the same time, the Diamond Prices Index has been ascending.
The numbers don’t lie. Between August 2020 to March 2021, the gold spot price dropped around 12.5%. During the same frame, the Diamond Prices Index increased 1.85%. Further, some analysts in the commodities space believe the trend will continue moving in opposite directions.
Why? For starters, because no two diamonds are the same, they have an artistic attribute to them that gold simply can’t replicate. Generally speaking, investments in fine art hold their value during recessions. If they do take a dip, eventually, they may see a resurgence. A piece of art is 100% unique and that characteristic caters to the mindset of the sophisticated affluent investor.
Again, this dynamic puts Lucapa in an envious position. You’re just not going to find the quality and size of the diamonds that Lucapa is delivering from its Lesotho and Angola mining projects just anywhere.
The other reason why gold is presently trailing diamonds is that the former market is now suffering its own demand crisis. In other words, the biggest driver of gold prices – fear of inflation – is not existent in the levels required to spark investor interest.
Admittedly, on surface level, the concept that inflation is not a top concern seems ridiculous, perhaps even irresponsible. After all, the New York Times recently featured a report entitled, “Inflation Fear Lurks, Even as Officials Say Not to Worry.” In the piece, the Times offered this expert analysis:
Jamie Dimon, chief executive of JPMorgan Chase, is among those tracking the inflation threat. “There’s a very good chance you’re going to have a gangbuster economy for the rest of this year and easily into 2022, and the question is: Does that overheat everything?” he said in an interview with Bloomberg Television last week.
In addition to the $1.9 trillion about to pour forth, Mr. Dimon said, $1 trillion in savings that piled up during the pandemic remain unspent.
Dimon assumes two upcoming events in his projections of possible inflation risk. First, he forecasts a “gangbuster” economy “easily” going into 2022. Second, he assumes that the American public will eventually spend a sizable portion of the $1 trillion in savings that accrued during the health crisis.
While we may appreciate Dimon’s optimism, this is also a risky position to take. For starters, no one knows how the Covid-19 pandemic will play out. Epidemiologists are still scrambling to understand whether new strains of the SARS-CoV-2 virus that are spreading everywhere can be addressed through current vaccines. If this crisis takes a turn for the worst, that could devastate the economy.
Moreover, even if the economy did improve, the U.S. manufacturing base has steadily declined from prior years due to outsourcing to China and other emerging markets. Therefore, if the Covid-19 crisis fades for good and demand returns, who will be the ultimate beneficiary?
Indeed, the comparison of the present rebound efforts to that of the U.S. post-World War II is erroneous for the simple reason that Americans never saw their manufacturing base impacted while the rest of the world largely laid in ruins. It was inevitable that the U.S. experienced an economic boom.
Today, the manufacturing base is not in the U.S. but in other countries. Further, the Covid-19 pandemic demonstrably proved that the American service sector can be duplicated anywhere in the nation, and therefore, it can be replicated anywhere in the world.
The only inflation that’s present is political delusions of grandeur. Americans are not the only people that run spreadsheets or speak English. If the global economy blossoms again, your eyes should look east toward the Asia-Pacific market. And that has significant implications for diamonds and LOM stock in particular.
The Red Dragon Rises
This is not to say that gold doesn’t have a place in one’s portfolio. Essentially, physical bullion is an off-balance sheet asset that sophisticated private investors have to protect themselves against chaotic economic and/or societal events. Again, with a 5,000-plus year history as a store of wealth, gold is and always will be relevant.
But in terms of overall returns, diamonds may be in a better position to profit stakeholders than the yellow metal. Not only are the forces of inflation not heavily represented, investors should really be worried about deflation.
Primarily, U.S. money velocity is down to near all-time recorded lows, which indicates that each unit of currency in the economy is not circulating at rates seen previously. That’s not inflationary but rather deflationary and incredibly so. Also, the personal saving rate is at multi-year highs, contradicting Jamie Dimon’s implication of a massive spending wave. If anything, Americans are saving money like crazy.
Robert Barone, Ph.D., a Georgetown educated economist, said it best. “Systemic inflation is a process and it occurs only when whatever is causing it is persistent.” Most importantly, Barone made an excellent point that everyone should pay attention to:
Last year, during the pandemic, because of the rapid move toward automation, productivity actually grew (4%) much faster than wages (1%). That’s deflationary!
In fact, when you consider long-term static wages and the decline of money velocity that started in 1997, you can make the argument that systemic deflation is the real threat. Logically, this wouldn’t support gold as its spot price would decline, turning off many investors.
But it’s an agnostic factor for diamonds, especially in the upper-tier market which really doesn’t suffer from economic boom-bust cycles due to incredible wealth insulation of its core buyers. Additionally, right before the pandemic, China had grown to become the world’s second-largest diamond market, mostly propelled by young buyers. Still, extremely affluent buyers undoubtedly played a major role as global manufacturing is now levered heavily in Asia.
As alluded to earlier, an international economic recovery will likely be first enjoyed by Asian nations. It’s simple capitalism. They own the means of production. They also own a large and educated workforce. Heck, even Hollywood – the symbol of American exceptionalism abroad – now needs China to survive.
With such economic advantages, Chinese buyers will turn their attention to diamonds for their unparalleled beauty and uniqueness. As evidence, Diamonds.net issued a report in February of this year about how Chinese diamond demand is pinging encouraging results:
High-end goods and anniversary buying are also going strong. The types of items commonly displayed on New York’s West 47th Street — top-quality large diamonds, fancy shapes, patented cuts, colored diamonds in yellow, pink and blue, and branded stones like Argyle pinks — have penetrated the Chinese market in recent years, thanks to suppliers from Belgium, Israel, India and the US. High-end diamonds and colored gems resumed selling after a few quiet months in the beginning of 2020, and many wealthy consumers believe now is a good time to purchase, as price points are reasonable.
Most significantly, the upper range of diamond demand is booming, according to Ephraim Zion, founder of Hong Kong-based luxury jeweler House of Dehres, stating, “Even though the international travel restrictions and quarantine policy pose a big problem/obstacle, the China market looks promising and is already in recovery, especially in the last few months. Prices for large diamonds have become stronger than two to three months ago.”
Zion noted that Chinese buyers don’t merely view high-end diamonds (the kind that Lucapa specializes in) as decorative luxuries but rather as mediums of value and financial security. Zion stated in an interview with Rapaport Magazine the following:
Under the low-interest-rate environment in China, the wealthy upper-class consumers and investors want to hold on to something more tangible, with high quality in mind. Chinese clients are more quality-conscious than any other culture in the world. If they want to purchase a diamond for milestone events, like a 20th or 25th wedding anniversary, they will choose higher quality grades instead of bigger sizes with lower color and clarity, and those who buy large white diamonds and fancy-colored diamonds such as pinks and blues are sophisticated clients who are knowledgeable about the diamond quality and market price.
Certainly, gold and other traditional safe-haven assets have their place. But increasingly, the relevant Chinese buyer sees superior-quality diamonds as the ultimate store of value. By logical deduction, publicly traded companies that cater to this demand will likely reap substantial rewards. Hence, astute growth investors are keeping close tabs on LOM stock.
An Unparalleled Discount
In every market cycle, you will inevitably come across a publicly traded company whose market valuation frankly does not match neither the present operational performance of the firm in question nor the likely forecasted value. Just on this basis alone, Lucapa Diamond Company Limited is priced at an irrationally low level.
But what makes LOM stock truly stand out is that the broader fundamentals supporting the underlying product is diametrically opposed to reality. The world’s most elite bankers along with preeminent news organizations consistently disseminate the narrative of inflationary fears. While anything can happen, the evidence overwhelmingly emphasizes that deflation is the real enemy.
To briefly summarize the deflationary ecosystem, we have:
- Productivity outpacing wages
- Money velocity near record lows
- Personal saving rate near record highs
- Outsourcing leading to fewer jobs
- Disappointing gold price trend
While gold can move on multiple factors such as societal fears and uncertainty, inflation is invariably one of its most robust catalysts. Without that, investors may look for better alternatives and that brings us to diamonds.
No one diamond is identical to another, giving each piece a unique story of its own. Moreover, high-end diamonds feature insulation from monetary factors (i.e. inflation/deflation) because their core buyers – sophisticated private investors – are themselves insulated from economic cycles.
On top of that, Chinese affluent buyers are eager to buy such gemstones for personal and financial reasons. With global wealth and commerce gravitating toward the Asian market, the high-end diamond space is rapidly becoming a no-brainer investment category. Therefore, the tailwinds for LOM stock couldn’t be any stronger.
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