In a world where fixed interest, property and cash all look unattractive, clients should look to invest in something that responds to money supply. What better than the works of dead artists?
Inflation is inevitable – buy a Picasso. And a Warhol and a Fontana and a Rauschenberg…
You probably think such a suggestion is a bit crazy, but I could not be more serious. So serious in fact we are telling all our clients and prospects to put at least 5% of their portfolios into art and I have created a fund that allows them to do that with a minimum investment of only £10,000/$10,000. The reasoning behind this unconventional assertion has its roots in Milton Friedman’s Quantity Theory of Money, informed by extensive independent art market research and the existence of new tools and products to help those new to art investing.
Why worry about inflation?
The press is filled with fretting over possible inflation, attended by increasingly nervous hang-wringing about ‘exit’ strategies. The basis of these concerns rests with the work of Nobel prize-winning economist Milton Friedman, and his Quantity Theory of Money and indeed may be of greater concern than watchers of the simple retail price inflation number may realise.
Let us start with Milton Freidman. Whatever you might think of the great market economist, his theory of money has been one of the most influential of the late 20th century. Apologies for reverting to basic economic theory – this is just a quick reminder to put inflation concerns in context. I refer specifically to Freidman’s formula that MV=QP. This formula asserts that the amount of money (M) in an economy, times the velocity (V) that money changes hands will equal the quantity (Q) of goods purchases times the price (P) of those goods. If you alter one side of the equation, you are going to affect the other side over the long run.
What does it mean for portfolio advisers? Let us use an extreme contemporary example with Zimbabwe, although history is littered with similar cases. The Zimbabwean government attempted to address its economic and financial difficulties by printing money, eg increasing M in our equation. Something had to give and, as numerous historical events have also reflected, it was prices (P). Prices soared out of control, pretty much in direct proportion to the amount of new money created. Another way to look at this is that the value of each measurable unit of currency fell until the total amount of currency in circulation equalled P times Q. Any way you choose to look at it, the result was out-of-control inflation.
A word of caution: I am not asserting that having used monetary stimulus to avoid a global financial catastrophe will now result in a global inflationary catastrophe. What central bankers did was probably both necessary and correct in the circumstances. I am saying that, however neatly monetary authorities in various countries exit their domestic monetary stimulus packages, MP will equal PQ in the longer run. That means the value of each unit of any given currency that remains in circulation will fall until the equation balances. You may have noticed I have not addressed V, but it comes into play now by determining the timing.
At the moment, monetary velocity (V) is probably negative, which is helping to keep the equation in balance. As soon as V turns positive – in other words, as soon as consumers have repaired their balance sheets and start spending again – P will rise based on the amount of money being pumped into circulation.
There’s inflation and there’s inflation
The way that official inflation measures are calculated simply does not reflect the economic reality. Just try matching up official inflation figures over time to housing costs, school fees, postage stamps, tube fares or a pint of beer and you will see what I mean. We are told these inputs are too ‘volatile’ to be included in official statistics so they are left out. But these are exactly the types of items that respond directly to the quantity theory of money calculation.
The price of these things has gone up steadily over the years, in a close approximation to the rate of money supply growth. ‘But other things have fallen in price’ I hear you say – computers or music CDs, for example. But these things have fallen due to an increase in quantity (Q) dramatically overwhelming any money supply influence on the price. We are telling people to allocate to real assets like art to protect themselves against both statistical and real levels of inflation.
Why art?
I believe long-term art prices reflect a direct relationship to money supply growth. I am nottalking about contemporary art, but art from well-known artists with established auction results. It also relates best to art from artists who no longer produce or who have passed on, which takes Q out of the equation.
You are left with a fixed quantity of an investible asset that is unleveraged. Over the longer term then, as velocity (V) turns positive, the price of art rises. If you consider art prices over the longer term – over 100 years, for example – that is exactly what they have done, grown on an annual return basis that roughly matches and often beats money supply growth.
In this respect, art is much like gold in that the price of both responds to money supply. A comparison of gold and art prices should therefore show a similarity and this is certainly the case. If you compare gold to the AMR Post-War 50 Index, it reveals a near-perfect correlation of 0.92. So given the dramatic rise in gold prices over the last year or two, we should be able to expect art to gain by similar amounts in coming months for the correlation to hold true.
Art and equities
Research from respected art investment research firm Mei Moses (artasanasset.com) shows art has demonstrated similar return characteristics as equities and indeed sometimes beats them. However, art markets usually lag equities by six to 18 months, because equity markets anticipate movements in the economy. Art, however, lags equity markets and usually does not recover until a cycle is fully underway and velocity (V) turns substantially positive.
Getting exposure to art
In order to invest in art that offers direct exposure to the money supply equation, and thus hedges against inflation, you need to buy art from deceased or non-producing artists. But no one would buy just a few stocks to get exposure to equity markets and the same is true for art. You need a broadly diversified portfolio of non-speculative art of this type for best effect.
With the price of Old Masters and even later Impressionists, costing many millions and pricing most investors out of the market, you are left with the Post-War period. Many high-quality pieces are available in this genre in the £300,000-£700,000 range, which allows an investment fund to assemble a well-diversified portfolio, which would not be feasible investing in Old Masters.
I believe so strongly in the long-term value of allocating to art for most types of investor, that I created a fund that does exactly what I have described. I wanted to offer our clients a way to allocate a portion of their portfolios to this asset class, without having to worry about things like picking artists, going to auctions, insuring or safeguarding the art. The fund takes these types of concerns away, and also actively manages the portfolio through leasing to exhibitions, which may earn income for the fund. In a world where fixed interest, property and cash all look unattractive, I am advocating that my clients allocate larger percentages of their portfolios to real assets, including gold, precious metals, other commodities and most definitely art.
Angus Murray, CEO of Castlestone Management
