Art Investing: The Inflation Hedge Nobody's Talking About

by Louis Basenese

Art Investing: The Inflation Hedge Nobody's Talking About

by Louis Basenese, Senior Analyst

Wednesday, June 3, 2009: Issue #1010

On Friday, my colleague and friend David Fessler provided you with four inflation hedges to consider.

Without question, I agree with all of Dave's recommendations.

I just want to add one more inflation hedge to the mix. It's an under-the-radar one that nobody's talking about. But they should be.

So let me tell you what it is - art investing. But let me stress why it's imperative you spread the love around and consider investing in all five inflation hedges, not just one.

"Inflation is coming, inflation is coming."

The world knows it. Even the guys at the switch - the Fed - can't deny it.

Last week, Philadelphia Fed President Charles Plosser warned inflation could heat up much sooner than expected.

Here's the problem. Everyone and their second cousin keep piling into the predictable hedge - investing in gold. The World Gold Council reports investment demand in the first quarter increased 248% to hit a record level.

Forget the contrarian implications. Such overcrowding, to an extent, means the profit pie will keep getting sliced up in smaller and smaller pieces. Moreover, when we get to the end of the inflation road, it implies the selloff will come fast and furious. I mean, look what happened last summer when the fire alarm sounded on oil. Prices collapsed 80% before anyone knew what hit them.

Here's all I'm suggesting. If everyone's clamoring for gold like they did last summer for oil, why not consider a road less traveled, especially if it promises equal, and possibly better, protection?

Yes. Such an investment exists. It's art investing.

Art Investing: More Than Art for Art's Sake

I crunched the data on gold, art and inflation since the end of the Bretton Woods system. For art, I used the Mei/Moses Fine Art Index, which tracks the prices of art based on repeat sales at auction, and captures 90% to 95% of the market.

Here's what I found:

  • Art's correlation with inflation rivals gold's.

  • Since 1997 art actually tracked inflation a tad better than gold, sporting a 0.26 correlation versus 0.24. (Remember, correlations range from 1 to -1, with 1 meaning prices move perfectly in tandem.)

  • And during the last bout of out-of-control inflation, from 1977 to 1982, art prices jumped a healthy 130%.

Now, I know what you're thinking...

Art's highly illiquid. Transaction, transportation and insurance costs can be excessive. Diversification can be difficult to achieve unless you're a billionaire. And most problematic of all, many of us probably don't know the difference between a Monet and a Manet!

The good news is you don't have to let these obstacles stand in your way...

Enlist The Help Of Art Investing Professionals

You can enlist the help of art investing professionals:

  • Like longtime friend of The Oxford Club, Mike Kuschmann, President of Fine Arts Limited in Winter Park, Florida.To get in touch with Mike, call Fine Arts Ltd. at 800.229.4322 or 407.702.6638, or email him at and ask for his free brochure pack.

  • Or renowned money manager and art expert, Debra Diamond, who I had the pleasure to speak with and hear present at this year's Investment U Conference.

Both can provide you with personalized art advisory and even discuss the potential tax advantages of investing in art. (Hint: gold does not offer the same advantage.)

Of course, some of you might be looking for a quick, cheap, no hassle art fix. Thankfully, one exists.

Track the Mei/Moses Index By Owning Sotheby's

It stands to reason we can track the performance of the Mei/Moses Index by owning the auction house, the company that will facilitate the sale of each piece of artwork that will eventually become the data for the index.

Well, only one trades on a U.S. exchange - Sotheby's (NYSE: BID). Granted, the current fundamentals leave much to be desired. But that will change.

As inflation draws nearer I expect well-heeled investors to bolster their art collections, especially while prices are depressed. And as inflation cools, they'll inevitably look to cash in on their hedges. In both instances, Sotheby's stands to profit.

At the same time, I'm encouraged by the highly cyclical nature of this stock. As the GDP growth resumes - and it will eventually - history dictates the stock will, too. If you have any doubt, check out this chart:

Sotheby's (BID) is the ultimate cyclical stock: It peaks right as the economy is peaking, and vice versa

No Perfect Hedge Against Inflation Exists...

The fact remains, no perfect hedge against inflation exists. Not one investment sports a correlation of one with inflation. So let me issue a word of caution - don't invest in only one hedge.

Or more simply, don't be a John Paulson.

The famed hedge fund manager who successfully predicted the subprime market collapse is piling into gold. Based on the latest SEC filings, his total position size in gold-related assets soared to 23.16%, or roughly $6 billion.

Let me assure you betting the farm, no matter how strong your conviction, leads to ruin, not riches, more often than not. Not to mention, once you lose it all, it's hard to make it back.

Bottom line, inflation is coming. But that doesn't mean you need to follow the narrow-mindedness of the herd into the most obvious and overcrowded hedge, gold. Instead, I recommend you diversify across the five options David and I have provided. And position size!!!

Good investing,

Lou Basenese

Today's Investment U Crib Sheet - Position Sizing

Position Sizing isn't difficult to understand, but it does take discipline to maintain.

Let's say you have $100,000 to invest and you're using the 1% risk model - never risking more than 1% of you assets in any trade - to guide your investments. If you're using a 25% stop loss, you could buy $4,000 worth of stock and risk $1,000 ($1,000 is 1% of $100,000).

In the example above, you placed 4% of your portfolio into the stock and set a 25% stop-risking just $1,000 of your money (since $1,000 is 25% of $4,000).

Some investors use even tighter stops, in the 10%-15% range.

If you're using the 1% risk model with a 10% stop loss, you could buy $10,000 worth of stock. You have the same dollar amount at risk ($1,000) as the first example - but you're allowing the stock less room to go down before you sell.

Using trailing stops can prevent large losses from becoming bigger ones, but they aren't infallible. A fast moving stock could go right through a stop.

Take a look at your portfolio today and make sure you know "how much" you have at risk. That way you'll be prepared regardless of what happens with any one position. You need to look at any position and be comfortable with the true amount of money you have at risk.

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