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This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on Nov 30 – Dec 6, 2015.

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MANDEL says the art market has mirrored the global economy in many ways and, notably, the early 2000s was an “exceptional period”. “Demand from China and its seemingly insatiable investment appetite drove a massive global commodity cycle. Today, the Chinese economy faces the difficult task of pivoting away from an economic model that is widely viewed as unsustainable in the long run.”

The Chinese art market — a proxy for surplus capital in the world that has to go somewhere or suffer depreciation — faces the fact that the years of break-neck growth have run their course, says Mandel. “Similarly, the trajectory of top art prices as a reflection of widening inequality must also eventually settle, though economists remain far from agreed on the path of the latter.

“While it might seem inherently undesirable for the market to cool off, silver linings abound. The Chinese market’s impending growing pains are symptomatic of a market that has come of age. And a cooling of top auction prices would provide a healthy rebalance from the upper deciles to the middle of the market, which would be a significant positive for the broader industry. 

“Finally, while there does not seem to be any other obvious candidate — like China or inequality — waiting in the wings to give the market its next big leg up, participants in the art market always maintain the option of just enjoying the aesthetics of the thing itself and not worrying too much about that.”

Going forward, what does this mean for art as an alternative investment? “To a certain degree, there may also be negative implications of slowing growth for the development of art as an alternative asset class. For instance, art hedge funds are part of a small but budding industry providing investors the ability to buy into speculative inventories of fine art,” says Mandel.

“The value-add of such businesses, in addition to art selection, is reaching a scale that would be difficult to obtain as an individual collector. However, the hurdle rate on such investments is quite high given the large implicit liquidity premium in a relatively small asset class — that is, investors need to be compensated for the relative illiquidity of the market. Slowing growth in the number of global transactions will do little to fix this problem and will maintain liquidity premia at a relatively high level. 

“Finally, slower growth reinforces the idea that successful investment in art is much more a question of identifying relative value than it is gaining exposure to the market as a whole; ships will rise less with the tide but some waves will ascend much higher than others. As such, while the structural factors underpinning the China market and top prices may begin to wane, it is not necessarily the case that opportunities in the art market have generally abated.”

Where did China take root?

Using more than 100 years of data, the Citi GPS report says the Chinese art market began to take form in 1996. The market had remained in an “early development state” with sales values staying relatively low until the mid-2000s. But from 2009 to 2011, as market volatility increased, sales grew from about US$3 billion to more than US$13 billion — a whopping 355%. The staggering sales volumes placed China’s art consumption parallel with that of the US.

China’s nouveau riche have been bankrolling the pricey alternative means of investment to diversify their portfolios, hoping that the steady rise in art and antique prices — which more often than not appreciate in time — will provide healthy financial returns. 

“This brought China’s art market, for a short time, more or less on a par with that of the US. Then, it dropped just as precipitously in 2012 — by nearly 30% — to US$9.5 billion,” says Artnet’s vice-president of marketing and business intelligence Thierry Dumoulin in the Citi GPS report.

He attests that Chinese wealth has had a significant role in the art market’s ascent as the Chinese are predisposed to holding a high proportion of their wealth in artworks and antiques. “While the average global holdings of so-called treasure assets such as art, antiques and jewellery are less than 10%, Chinese high-net-worth individuals hold an average of 17%, versus 3% in India, 9% in the US and 7% in the UK.

Citing data from auctions in 2013 and 2014, Dumoulin indicates a potentially significant contraction in 2015, which could jeopardise China’s No 2 spot in the global art market. Ironically, four days before Citi issued its report, a painting of a nude woman by turn of the 20th century artist Amedeo Modigliani was purchased for US$170.4 million by Liu Yiqian, a former taxi driver turned billionaire art collector. According to The New York Times, it was the second highest price paid for an artwork at auction.

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