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A Theoretical Approach to Valuing Antiques and Fine Art

One of the enduring enigmas of investing in art is valuation. Unlike traditional financial assets that are largely priced according to expected future cash flows, fine art has no future cash flows except for the ultimate sale proceeds. In this regard art is similar to a zero coupon bond. Of course, the future selling price of any piece of art is unknowable in the present. This presents any would be financial analyst of the art world with a conundrum. A fair valuation – and by extension a reasonable performance estimate – cannot be made without knowing the future sale price of a work. Using expected future cash flows as a valuation method for art and antiques is therefore a doomed exercise in circular reasoning.

For a long time, this problem bedeviled me. Relative valuation, in comparison, is a much more approachable riddle in the world of antiques; items of higher quality and condition are generally worth more than those of lower quality and condition. But absolute valuations stumped me. How do I know that the antique I’m considering is priced fairly compared to stocks, bonds or other traditional financial assets?

But then it hit me. Maybe I was approaching this issue from the wrong angle. Rather than trying to determine valuation from unknowable future cash flows, maybe I should be looking at the amount of money available in an economy to buy art. In other words, I should look at the inputs (available money) rather than outputs (future sale prices). According to my hunch, inputs in this instance would be nominal (non-inflation adjusted) GDP (gross domestic product) – the value of all goods and services produced in an economy during a year.

So I started gathering data. Now historical price information for art and antiques is somewhere between difficult and impossible to find. However, after significant effort, I managed to put together a miniature index of U.S. type coins with price data back to 1950.

This index consists of three equally weighted constituents:

1) 1842 Liberty Seated silver dollar in XF condition (mintage: 184,618)

2) 1857 Flying Eagle cent in XF condition (mintage: 17,450,000)

3) 1908-D no motto $10 Indian Head gold eagle (mintage: 210,000)

These coins were very specifically chosen. They are all classic pieces that have been popular among U.S. coin connoisseurs for many decades. Although not plentiful, none of the pieces is a rare or key date. Only one coin is gold, limiting the impact of gold spot price fluctuations on the overall index. And because they are all U.S. coins, we can surmise that nearly all collector demand for them originates in the United States. This allows us to exclusively look at U.S. economic data in an attempt to find a meaningful correlation. In addition, our U.S. type coin index, possessing all the desirable attributes of investment grade antiques, should be an excellent proxy for the broader art and antiques market. So any relationship with economic data we find here will most likely carry over to that larger market.

This first chart shows our proprietary U.S. type coin index graphed from 1950 to 2015 against both nominal U.S. GDP and the U.S. inflation rate (CPI). You’ll notice the very close relationship between the coin index and nominal GDP. The correlation coefficient between these two data sets is 0.943, a very high number indicating almost perfect correlation. To put this value in perspective, a correlation coefficient of -1 means two data sets are perfectly inversely correlated. A coefficient of 0 means two data sets are completely non-correlated, moving randomly in relation to each other. And a coefficient of 1 equals a perfect correlation. Inflation, useful as a reference baseline, lags far behind. The coin index and nominal GDP moving in almost perfect sync seems to confirm my theory that nominal GDP is the primary driver of collector demand. This makes a lot of sense, as art aficionados and antique collectors are constrained by their available resources and nominal GDP is a reasonable measure of those resources.

But we can take this data one step further. We can plot a ratio of our coin index versus nominal GDP to reveal periods of overvaluation and undervaluation. This is what our second graph shows. In this case, the long term average has been indexed to 1. So any number around 1 implies fair value while those significantly above signal overvaluation and those substantially below show undervaluation.

The results of our graph are intriguing. We can see that most of the period from the 1960s through the 1980s shows persistent overvaluation in the coin index. This period also broadly coincides with an elevated rate of inflation. So the story seems fairly straightforward. People who fear inflation flee underperforming stocks and bonds for the relative safety of tangible assets, including bullion, art and antiques. This phenomenon eventually pushes these tangible asset classes into overvalued territory. Our proprietary coin index almost reached double its fair value in 1975.

The period on our chart from 1995 to 2015 is equally illuminating. Once inflation receded and traditional financial assets began performing well again, people tended to abandon tangible asset en masse. This drove valuations well below fair value for the last 20 years. Although the coin index – and investment grade antiques in general – bounced off its year 2000 low of 0.57, tangibles are still substantially undervalued today. The latest 2015 data point for the coin index is 0.64, meaning a rally of more than 50% would be needed to return to our long term average valuation.

But how can we be sure our coin index data isn’t a fluke, or perhaps just coin specific? Well, I also managed to get some historical data on the Antique Collector’s Club Antique Furniture Price Index. This is an index started in 1968 by John Andrews that tracks the performance of 1400 types of commonly seen antique British furniture. It is divided into seven categories: oak, walnut, early mahogany, late mahogany, Regency, Victorian and country. Antique furniture is a radically different kind of market than coins. So if we find the same relationship to nominal GDP here that we found in the coin index we can be assured that it is meaningful. However, one caveat about antique furniture is that it is not, in my opinion, technically investment grade. This is due solely to the fact that furniture is not portable, a requirement for investability by my definition. But we work with the data we have, not the data we want.

The next chart shows the ACC Antique Furniture Price Index from 1968 to 2015 versus U.K. nominal GDP and the U.K. inflation rate (RPI). You can immediately see the tight relationship between the furniture index and U.K. nominal GDP from 1968 to 2002. At that point the relationship seems to break down. Looking at correlation coefficients confirms this analysis. From 1968 to the index’s peak in 2002, the correlation coefficient is a near perfect 0.974, but if we look at it over the entire period, the correlation coefficient drops to 0.710. This is still a fairly good correlation, but not nearly as close as it had been until 2002.

What happened? Well, the antique furniture market has been undergoing a tumultuous period for the last 15 years or so. Specifically, living arrangements have been changing. Smaller houses, condos and apartments are now the norm. So a lot of massive antique furniture from bygone eras simply doesn’t fit in the average home anymore. Also, many people are overly indebted. They struggle to make the monthly payments on their massive mortgages, car loans and credit cards. Paying top dollar for antique furniture isn’t a top priority when you’re barely making ends meet.

This leads us to our last graph. It shows the ratio of the ACC Antique Furniture Price Index to U.K. nominal GDP. And it shows a remarkably similar story to our coin index chart. A period of overvaluation in the 1970s through the early 1990s turns into extreme undervaluation for the most recent 10 years. As of 2015, the furniture index to GDP ratio rests at 0.40, indicating a 150% increase would be necessary to reach fair value.

Now I would take this indication of extreme undervaluation in the antique furniture market today with a grain of salt. While I do feel that antique furniture is undoubtedly selling too cheaply, lifestyles have changed in the last couple of decades – perhaps permanently. Fair value may be lower today than the (still evolving) long term data says it should be.

In any case, I think there are a few important points we can garner from this data. First, we can successfully measure the absolute value of art and antiques. Second, art and antiques as an asset class tend to appreciate at the same rate as nominal GDP growth over the long term. Third, inflation and the accompanying underperformance of paper assets lead to periods of overvaluation in antiques while booming stock markets and low inflation rates give birth to secular undervaluation. Fourth, all indicators show that tangible asset classes like art and antiques are somewhere between moderately undervalued and egregiously undervalued today. It is clear that there has rarely been a better time to become a connoisseur of fine art.

The Decline of American Retail

The United States is a consumer oriented society. We have more retail square footage per capita than any other nation on earth. We developed the concepts of “retail therapy” and “shop ’til you drop” as (unhealthy) ways to manage psychological problems in our lives. There is no way around it; Americans love to shop.

But the retail space has been changing rapidly over the last 20 years. The rise of internet retail – with Amazon.com as its poster child – is just one example of the epochal change that is taking place. Many people would call this sort of change a good thing, ultimately. And I won’t argue with them. But there is another, darker side to the changes in retail that is important for both investors and consumers to understand.

Our bubble prone economy has massively overbuilt commercial retail space. A corollary of this assertion is that we have far too many retailers. Put quite simply, there aren’t enough retail dollars spent in an average year to support the companies and infrastructure currently occupying the retail sector. Up until now, this fact has been obfuscated by three poorly recognized trends. But these trends are reaching their conclusion, leaving the United States with a potential retail apocalypse on its hands.

As the pool of discretionary retail dollars shrank in the aftermath of the 2008-2009 Great Financial Crisis, small retailers tended to feel the pinch first. These were the proverbial mom and pop shops, with a handful of store locations or less. While the nature of these retail establishments could vary considerably – florists, convenience stores, antique & consignment shops, restaurants, specialty retailers, etc. – they all had one very important element in common. None of them had access to the capital markets. They could issue neither stock nor bonds to raise capital.

This placed these small businesses at a distinct competitive disadvantage compared to larger chain retailers. In our current era of near zero interest rates, large companies could easily tap cheap public market financing to support their operations while sole proprietorships couldn’t. Consequently, in the years since the Great Financial Crisis, a massive number of these small retailers have gone out of business. See my related articles on The Bittersweet Goodbye of the Physical Antique Store and The Great Boston Antique Store Massacre of 2011-2012 for more details.

The second overarching trend has been consolidation among the remaining American retail chains. A perfect example of this phenomenon was the 2005 merger of Federated Department Stores (owner of Macy’s) with The May Department Stores Company (owner of Filenes, Marshall Fields and Lord & Taylor). Once two large corporations merge, overlapping store locations can be closed and smaller, non-core operations can be sold or spun-off. These actions help reduce competition and stretch the limited pool of available retail dollars further.

But even these developments didn’t keep up with the decline of the American consumer, beset as he is by excessive consumer debt, lack of salary increases and anxiety over job security. So, over-levered corporate retailers began to liquidate next. These American retail companies had tapped the high yield bond market until even the stupidest bubble-head money manager won’t lend them another dime. Electronics retailers like Circuit City (2008) and RadioShack (2015), book seller Borders (2011), video rental shop Blockbuster (2010) and home goods store Linens & Things (2008) are all examples of national retailers that have declared bankruptcy and subsequently liquidated due to the difficult retail environment.

I think it is important to note that the first two trends I listed above leave equity and bond investors in the retail space completely intact. Wall Street loves this, in spite of the fact that it is cannibalistic behavior. The large, stronger corporate retailers eat the small, weaker mom & pop shops first. When there are no more small retailers to feast on, the big corporations begin to devour each other in mergers. But once all the mergers that make sense (and some that don’t) have happened, the weaker national retailers begin to fail.

Now we are progressing to the next ominous phase of our peculiarly American retail disease: poor sales results from previously strong national retailers. Target, J.C. Penney and Macy’s are just a few of the large physical retailers that have reported disappointing sales numbers in 2016. These massive corporations are caught between the inexorable pressure of ultra-low margin online retailers like Amazon.com on the one side and overextended consumers who are relentlessly cutting back on spending on the other.

The future is clear; more American retail chains will liquidate in bankruptcy. In fact, it is probable that household names that have defined their respective retail spaces for generations will come to an ignominious end. One dead store walking that comes to mind is Sears, an original pioneer of mail order catalogues back in the late 19th and early 20th centuries. They were, ironically, the Amazon.com of their day. And they will soon be gone.

The world is changing. And investors holding shares or bonds in the affected companies who do not take heed will feel the pain. It is yet another reminder that your investment dollars may very well be safer in investment grade art and antiques than traditional financial instruments.

Investing in Contemporary Art Direct from the Artist

If you’ve spent any time reading AntiqueSage.com, you know that I have a strong preference towards antiques as investments. Antiques are works of art that have stood the test of time, having been seasoned over decades, if not centuries.

This process tends to weed out specimens constructed of inferior materials as well as fad-based items, leaving a higher percentage of investment-grade examples. So when I’ve occasionally wondered to myself if successfully investing in contemporary art or new luxury goods by buying them directly from the artist or craftsman is possible, the answer has always been “No”.

But then I had an experience on Etsy that changed my mind. I was perusing the online, peer-to-peer, handmade/vintage centric website for antique jewelry when I stumbled across something rather astonishing: a new piece of jewelry that was investment grade and sensibly priced!

This was something I didn’t expect. Normally, luxury goods are far too expensive when new to make reasonable, much less good, investments. The average markup over cost normally runs 100% or even higher. It is easy to see under these circumstances why buying new luxury goods for investment purposes is a fool’s errand. It is far better to buy them in the secondary market for discounts of 50% or greater.

And yet here I was, staring at a beautiful investment grade, abstract modernist pendant that was selling for only $365. In cases like this, calculating an estimate of the item’s intrinsic value can be a useful starting point. I immediately began to crunch the numbers.

The jewelry had modest intrinsic value from its precious metal content – about $30 or so. It was also set with two natural sapphires: a small, round-cut, beryllium-diffused orange sapphire and another, much larger natural, purple-pink, marquise-cut sapphire. The beryllium diffused stone was only worth $8 or $10.

The 1.27 carat purple-pink sapphire was the real treasure here. Even at a lowball price of $200 a carat, the stone was still worth over $250 by itself. Altogether, the intrinsic value of the piece was around $300 using fairly conservative assumptions. As an added bonus, the jewelry had been cast in a cuttlebone mold, an ancient technique that destroys the mold in the casting process. As a consequence, this pendant was one-of-a-kind, a factor that significantly enhanced its desirability.

The aggregate material value of $300 meant that the piece was only selling for about $65 in excess of its intrinsic value. This modest $65 premium reflected both the item’s considerable artistic merit as well as its undeniable usefulness as a piece of jewelry. I was very interested.

But another question quickly popped into my head. How could the selling artist afford to let the piece go for so little money, especially after Etsy takes its cut? He must have spent a minimum of several hours designing and crafting this pendant, and a wage of no more than $15 or $20 an hour at best for his considerable skills seemed unrealistically low.

So I read up on his background, discovering that he was more or less an old hippy from Southern California. He had started out in the mid 1970s cutting gemstones, eventually stumbling into gold working and then full-fledged jewelry making. I surmised that he probably had low expenses – no million dollar mortgage or $1,000 a month student loan payments here. It is also possible that he scored a deal on the sapphires used in the pendant, given his extensive background with gemstones.

In any case, I was satisfied that the jewelry was as represented and a bargain at $365. I wasn’t disappointed either. After purchasing it, the pendant I received was a wonder of modernist design – at once sleek, organic and, above all, stunningly beautiful. It was a remarkable find.

This pendant changed my thinking about the viability of investing in contemporary art direct from the artist. I now think it is possible, although still very difficult.

New art is disadvantaged versus antiques in several ways. First, it lacks seasoning, which helps reduce undesirable specimens. Second, it is often overpriced, rendering future investment returns poor, or even negative. Finally, when scrutinizing contemporary art I believe it is imperative to de-emphasize the artist and focus very intently on the quality and materials of the work itself.

Ultimately artists – especially new, unproven artists – don’t sell art. Beauty and fine workmanship do. In spite of these drawbacks, buying contemporary works direct from the artist may be one of the most overlooked ways to invest in art today.

Japan – Land of the Rising Investment Grade Art

I’m constantly challenging myself to discover new types of investment grade art and antiques. But this search isn’t an easy one. The ideal investable antique should possess five different attributes: durability, portability, scarcity, and quality of materials and construction. In addition, an item should reflect the era or culture in which it was created – an attribute I term zeitgeist. These five elements together form the delightfully zany acronym DPSQZ. They are also the basis of universal desirability which is ultimately the foundation of investability.

However, following these five principles naturally tends to lead in certain directions. For example, high quality materials and durability are joined at the hip. Precious metals and precious gemstones are some of the most lasting, stable materials known to man. Therefore it is only natural that antiques that incorporate them frequently appear on the list of investment grade art and antiques. And yet I strongly believe that art does not have to possess significant intrinsic value in order to be desirable and investable.

This has prompted me to exhaustively search at the periphery of the art world for possible investment grade art. Why the periphery? Well, the major arts – painting and sculpture – are well trodden asset classes by this time. The luminaries and great artists of these fields are well known. Even an expert in the field is rather unlikely to suddenly “discover” a previously unrecognized or unappreciated artist. There is a great deal of reference material about paintings and sculpture in existence, and, as a corollary, decidedly few bargains available to the collector. This doesn’t necessarily make them bad investments, but it does make them less interesting from an investment standpoint.

What I have noticed time and time again in my endless search for unconventional, investment-worthy art is the amazing artistic talents of the Japanese people. Historically eschewing personal adornment and conspicuous displays of wealth, the Japanese instead turned everyday functional objects into glorious works of art. The list of their artistic accomplishments is truly impressive. Expertly crafted samurai swords, delicately carved netsuke, intricately decorated tsuba, beautifully embellished lacquerware and alluringly modern shin-hanga woodblock prints are all examples of conventional antiques elevated into art forms by the Japanese. These traditional Japanese crafts may have little to no intrinsic value, but are all solidly investment worthy.

Perhaps it isn’t surprising, but the Japanese still produce luxury goods of unparalleled beauty today. Obsessive attention to detail and dedication to their chosen craft are truly admirable traits that shine through in many Japanese luxury products. And while I don’t normally advocate buying new luxury goods for investment purposes, some Japanese items are so superlative in terms of quality that I may be willing to bend my own rules.

I don’t intentionally target Japanese art when looking for unrecognized, investment grade art. In fact, I go out of my way to try to find unknown art and antiques from a variety of regions and cultures. And yet I continually find myself drawn toward Japanese works again and again. The Japanese people’s artistic skill – particularly with highly-detailed, miniature work – is the stuff of legends. Their aesthetic reputation for both graceful simplicity and delicate naturalism is unrivaled. When searching for aesthetically pleasing work that is universally desirable, I believe you must go where the fundamentals lead. All too often, the final destination is Japan – the land of the rising investment grade art. And that isn’t necessarily a bad thing.

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