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Tangibles (precious metals, commodities, and collectibles)

     Tangible is a term that typically refers to something that can be touched, and tangible investments usually refers to assets that have some function. Precious metals like gold, platinum, and silver, along with other commodities, gems, and art are typically classified as tangibles. Coins, stamps, books, antiques, furniture, rugs, Chinese ceramics, and other collectibles are also often included in the category.

     Investing in gold and some other precious metals and commodities has become much easier and cheaper thanks to ETFs that were created to provide exposure. But historically tangibles have been differentiated from other investment classes by limited marketability, high maintenance and high information costs.

     Gold has historically been a store of value and was commonly used as currency. The primary reason not to invest in gold is that over long periods of time it has had real returns (net of inflation) near zero. In other words, investing in gold has generally returned the equivalent of inflation.1 Other negatives include the costs of acquisition, storage and insurance which may result in negative real returns. The Wall Street Journal noted in 2017 that the government sells gold-coin proofs at a 25% markup over per-ounce gold prices.2

     Additionally, commodity prices can fluctuate widely, exposing investors to significant risk. In contrast, an investor in T-Bills or CDs has an advantage over gold investors in that they usually have little, if any volatility.

     Arguments that can be made for investing (as opposed to speculating) in gold and similar commodities include diversification (although other assets offer diversification benefits with higher returns), maintaining a portfolio in proportion to current world wealth, and insurance against catastrophes.

     Claude Erb and Campbell Harvey estimated the market capitalization of gold at 10% of the combined capitalization of the world’s stock and bond markets in a 2013 paper titled “The Golden Dilemma.”3 They studied gold prices over 2,000 years and argued that gold may be a good inflation hedge over many centuries, but a poor inflation hedge for horizons of up to 20 years. They also argued that gold is an unreliable currency hedge, particularly in periods of extreme stress, like during wars.

     There are many publications and studies that estimate the percentage of wealth stored by investors in tangibles or non-financial assets. Knight Frank publishes wealth reports and typically estimates ultra-wealthy individuals worldwide have 6% of their wealth in collectibles (cars, art, wine, etc.).4 Other researchers have estimated nonfinancial assets at around 17% for high net worth investors, but the percentages in some other countries can be above 50%.5

     Elroy Dimson, Paul Marsh, and Mike Staunton estimated collectible returns over 118 years at 2.9% versus 5.2% for global equities. Classic cars were the best performers while rare books were the weakest among the collectible categories for which they have data (which also included stamps, jewelry, and violins). They estimated 23% of U.S. assets are non-financial, but in China its 56% and in Russia its 89%.6

     There have been several well documented arguments made for investing in some tangibles. For instance, a 2006 paper argued that precious metals offer some hedging value and portfolio performance benefits (using data from 1976 to 2004).7 Another paper published in 2009 concluded that adding precious metals to your portfolio did increase returns and reduced risk over a 34 year period.8 Nigel Lewis also suggested in a 2009 paper that adding a small to moderate amount of commodities can reduce the volatility of portfolio returns and improve the risk-adjusted return over the long term.9

     Investors should be careful not to confuse investment with consumption when evaluating tangibles. Lack of liquidity and high volatility can put nonspecialized investors at a disadvantage. Additionally, most tangibles do not pay dividends or have any kind of income. Aesthetic pleasure is art's dividend. Many advisors recommend purchasing tangibles for pleasure, not for investing purposes.

     A November 30, 1996 article in the Economist titled “Has Wall Street's buying fever infected the art world?” had some interesting commentary on the art market, including the following excerpts.

"The art market experienced a surge in the late 80's as a bubble in Japanese stocks and property prices suddenly brought Japanese buyers to auction rooms around the world ... But when the property bubble burst in 1991, the air rushed out of art values as well. International art prices fell by 40% that same year, according to Art Market Research, a British consultancy ... while precious art may be a fun way to spend your wealth, it is not necessarily a smart way to invest it. For a start, the financial gains that art generates are very different from those of a stock or a bond. Paintings do not pay dividends. And if you need to raise a little cash, it is difficult to liquidate a sculpture one limb at a time ... a work of art can not be priced with financial formulas. It is ultimately worth only what some other collector is willing to pay. To shell out millions now, in the hope that someone else will shell out even more in the future, is risky indeed."

     William Goetzmann is an expert in art and author of “Accounting for Taste: An Analysis of Art Returns over Three Centuries." Goetzmann studied art transactions from 1714 to 1986 and found annual returns of 3.2 percent.10

     Researchers analyzed a sample of over 20,000 paintings that were sold repeatedly at auction between 1972 and 2010. They argued that the returns of fine art had been significantly overestimated, while the risks have been underestimated. Paintings with higher price appreciation are more likely to trade, which biases estimates of returns. Their selection-corrected average annual index return was 6.5 percent, down from 10 percent for traditional uncorrected repeat sales regressions.11

     William Baumol calculated art market returns over three centuries (1650–1960) and found that the average annual real (inflation-adjusted) return was about 0.55% (the real return on bonds over the study period was about 2.5%). He used the term “floating crap game” and suggested the difference effectively equates to the aesthetic pleasure in art investments.[12]12

     Gary Gorton and Geert Rouwenhorst published an intriguing article in 2006 arguing that using data from 1959 through 2004, collateralized commodity futures had similar returns and risk to U.S. stocks.13 But, in the same issue of the Financial Analysts Journal, Claude Erb and Campbell Harvey published an article disagreeing with those primary conclusions. They concluded “historically, the average annualized excess return of the average individual commodity futures has been approximately zero and commodity futures returns have been largely uncorrelated with one another.”14

     Ben Carlson followed up on that debate at the start of 2018 and summarized that from 2006 through 2017 the Bloomberg Commodity Index lost more than -41%, while the S&P 500 was up over 175%.15 Dan Weil was particularly blunt in a July 2019 article in "Wealth Management" titled "Advisors Should Avoid Commodities" (and subtitled "Commodities are for traders and have no role in a client’s long-term portfolio").16 He wrote the "inflation-adjusted Economist commodity-price index has returned close to zero since 1871" and that the "S&P GSCI commodity index returned ... negative 11.5% for 10 years."

     Personally, I am much more of a critic than a fan of “investing” in tangibles. My wife and I received some small gold bars as wedding gifts and I also own 100 shares of the gold ETF IAU that I purchased in 2010, primarily because a client wanted to buy gold and I like to participate in gains, and suffer from losses alongside clients. I also have a very small position in VGPMX Vanguard’s Vanguard Global Capital Cycles (previously called Precious Metals and Mining) Fund for myself and some family members. Precious metals mining equities have historically performed better than precious metals themselves and logically it makes sense to own the business rather than the commodity, but investors in them should be prepared for volatile returns regardless. For those that do feel comfortable with commodities it might be helpful to consider mining funds as a potential hedge during weak economic periods. The long term case for other investments like stocks and real estate is much stronger though.

Notes - The Footnotes in the Book are sequential and for this chapter start at #372 and end at #387.

1. Source: Stocks for the Long Run by Jeremy Siegel
2. U.S. Mint’s Gold and Silver Coins Turn to Lead for Some Retirement Investors, November 26, 2017
3. Claude Erb, Campbell Harvey, The Golden Dilemma, Financial Analysts Journal July/August 2013
5. Jordà, Knoll, Kuvshinov and Taylor (2017) “The Rate of Return on Everything, 1870-2015.” FRB San Francisco Working Paper 2017-25.
See also Ravina, Viceira, and Walter (2011)
6. Elroy Dimson, Paul Marsh, Mike Staunton , Credit Suisse Global Investment Returns Yearbook 2018 Summary Edition , February 2018
7. David Hillier, Paul Draper and Robert Faff, "Do Precious Metals Shine? An Investment Perspective" Financial Analysts Journal March/ April 2006
8. Mitchell Conover, Gerald Jensen, Robert Johnson and Jeffrey Mercer, Can Precious Metals Make Your Portfolio Shine? The Journal of Investing, Spring 2009
9. Nigel D. Lewis, Is There a Role for Commodities in Long-Term Wealth Accumulation? The Journal of Wealth Management, Fall 2009
11. Arthur Korteweg, Roman Kräussl, Patrick Verwijmeren, Does it Pay to Invest in Art? A Selection-Corrected Returns Perspective, October 15, 2013
12. William Baumol, “Unnatural Value: Or Art Investment as Floating Crap Game.” American Economic Review, May 1986
13. Gary Gorton and K. Geert Rouwenhorst, Facts and Fantasies about Commodity Futures, Financial Analysts Journal, March/April 2006
14. Claude Erb and Campbell Harvey, The Strategic and Tactical Value of Commodity Futures, Financial Analysts Journal, March/April 2006
16. Dan Weil, Advisors Should Avoid Commodities, Wealth Management, July 18, 2019

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