From the April 2009 issue of Research Magazine • Subscribe!

Hanging Investments on the Wall

Who: George Wachter, Vice Chairman, Old Master Paintings, Sotheby's

Where: Caf? Boulud, 20 East 76th Street, New York, February 20, 2009

On the Menu: Fois gras, coq au vin, and the enduring value of Old Masters.

For about a year, many people have been warning that the current economic crisis could rival the Great Depression in terms of the devastation it will inflict on the economy. By some measures it already does. When I arrive for my lunch appointment at Caf? Boulud, an Upper East Side French restaurant favored by the art dealer community, the shares of General Motors trade at their lowest levels since 1938.

The old statement, "What's good for GM is good for the United States of America," keeps popping into my head. The reverse must also be true.

This is why I want to chat with George Wachter, vice chairman of the premier art and antiques auction house Sotheby's. In a previous issue of Research, "Food for Thought" explored gold as an alternative investment in an uncertain financial market environment. In fact, the day I meet Wachter the yellow metal trades above $1,000 per Troy ounce for the first time since last July. Now, I want to discuss another timeless asset, fine art and other collectibles.

Wachter points out that his specialty, Old Master paintings -- works painted in Western Europe before around 1800 -- are very much like gold because their appeal and their value have held up over centuries. Even better than gold, because there is plenty of gold around and more is being mined every day, whereas there will never be another Old Master painting.

"Companies go bankrupt all the time," says Wachter. "Even countries can go bankrupt. But Old Masters have endured."

However, Wachter starts our conversation by talking about a more transient financial asset -- notably, the price of Sotheby's stock. Trading on NYSE under the clever symbol BID, the shares of Sotheby's Holdings, Inc., spiked above $60 in October 2007, but they have been literally decimated over the past year, falling below $7.

"It has been completely incomprehensible to me," says Wachter.

Admittedly, the company posted a worse-than-expected loss in the third quarter, and in October-November the slump in the market came very suddenly after so many good years. Nevertheless, Sotheby's is going to remain profitable, Wachter asserts, and has plenty of cash on hand. It is also responding to the new environment promptly, reducing staff and cutting costs. "I don't think anybody really understands what is going on in the market."

This is pretty alarming coming from someone who has been at Sotheby's since 1973, has been involved in the sale of such important collections as the New York Historical Society and the estate of Walter Chrysler and has seen a number of ups and downs in the art market.

Battered Art Prices

Actually, Sotheby's has been marked down for two reasons. One aspect of the company's business is to provide financing to clients with works of art as collateral. Anything having to do with credit has lately been a dirty word for investors. More to the point, the art market, along with commodities and real estate, has been one of those asset classes that got disproportionately inflated during the years of easy money.

However, the art market consists of several very different segments, Wachter explains, and each has its own dynamics. In recent years, prices have been particularly high in the contemporary art segment, which is also where most speculative interest has been concentrated. Investors have been drawn in by stories about a collector buying a secondary work by Andy Warhol, for example, and reselling it for 10 times the original price a few years later.

Speculative interest has now dried up and contemporary art prices have fallen sharply. This market segment has been closely correlated with the stock market. In some cases it has been hard to find buyers at any price.

On the other hand, Old Master prices have generally held up and Sotheby's January sales were generally good, says Wachter. Even though overall auctions fell short of the estimate, they still totaled $57.7 million. A painting by British artist J.M.W. Turner, the top seller, brought in $13 million.

Other parts of the art market were especially hurt by the sudden disappearance of newly rich buyers from emerging countries, such as Russia, who did much to inflate prices in recent years by bidding without regard to value. Some old-time collectors have stayed out of the market lately, because they thought the prices had become too high.

In the Old Masters market, says Wachter, even his Russian clients were generally more judicious buyers who knew what they wanted and at what price. On the other hand, they have not disappeared so precipitously in recent months.

Still, there is no denial that the art market has slowed. "There has been a flight to quality," admits Wachter. "If you have a mediocre picture, you shouldn't be trying to sell it in this environment."

Then again, the strange and unpredictable climate creates opportunities for those who have the money and know what they are buying. Suddenly, there are bargains to be had -- for the first time in years.

Not only for the Super-Rich

Art collecting -- especially something as established as Old Masters -- definitely has the reputation of being a pastime for the extremely wealthy. Not necessarily, says Wachter. You do need to have disposable income, he admits, but he also points to a client who has been buying Old Masters in the $15,000-$25,000 range. You can hardly buy top quality works by household names for that much, of course -- and top quality Old Masters have been mostly tucked away at museums by now, in any case -- but you can still find inexpensive good paintings.

"This client -- he is a collector by now, really -- has put together a collection for not much more than $100,000," says Wachter.

Art tends to retain its value and appreciate over time. It could protect wealth in an uncertain environment such as now, and it could be a hedge against inflation if the government keeps printing more money and borrowing and thus unleashes a bout of severe inflation. However, Wachter warns that art collecting is not something you should get into for pure investment purposes or for speculation.

"To put together an Old Masters collection you need to have a thought," he says.

To be a successful and shrewd art collector requires knowledge, interest and a passion for art. Only then could it be a great investment that you can also hang proudly on your wall.

Art has other drawbacks as an investment. Commissions are extremely high; at top auction houses, which guarantee both the quality and provenance of the works they sell, commissions average around 20 percent -- or 40 percent on a round-trip. Flipping that Rembrandt is not going to work as easily as it used to in real estate. And, besides, art works are illiquid even in the best of times.

Despite the proliferation of real estate investment trusts, exchange-traded funds and other financial instruments which allow investors to take positions in oil, gold, real estate and other assets without physically taking possession of them, nobody has yet come up with a good way to sell shares in an Old Master painting to retail investors. But if art retains its value better than paper dollars in the current environment, owning shares in Sotheby's could provide at least some exposure to those timeless masterpieces.

But then again, you can't hang them on the wall.

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NOTE: Photo by Leeza Semionova
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Alexei Bayer runs KAFAN FX Information Services, an economic consulting firm in New York; reach him at abayer@kafanfx.com. His monthly "Global Economy" column in Research has received an excellence award from the New York State Society of Certified Public Accountants for the past five years, 2004-2008.

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