There is method in the madness, even in a boom

Changing tastes, as much as changing economic conditions, could bring a halt to the seemingly inexorable rise at the top end of the market

Record is the word most frequently used in the press releases issued by Christie’s and Sotheby’s, following the most recent round of contemporary and Modern sales in New York, where around $2.5bn worth of art was sold in one week. To some, this spectacle is reminiscent of Barbara Kruger’s giant billboard of 1987 that screams “our prices are insane”. And it is difficult to resist the temptation to oversimplify this phenomenon and describe it as a bubble that is destined to burst.

The reality, however, is much more complex. By scrutinising the notoriously difficult-to-analyse art market we can discern a great deal of method in the perceived madness.

Certainly the collector who bought Picasso’s Les Femmes d’Alger at Christie’s for almost $180m is betting on crushing the bar of $200m the next time the painting comes to market: because of the buyers’ premium, $201m is the minimum price the Picasso canvas would have to sell for at auction for the collector to avoid a loss. Of course, if the owner is going to donate it to a museum, financial considerations are less relevant. This is one of the complexities of the art market: the price of individual works depends on a number of factors, including the motivations of buyers, which are difficult to discern.

Are rising prices sustainable?

To understand whether the current escalation in prices is sustainable, it is necessary to change the way we think about the art market. Instead of thinking of different markets related to different artistic periods, we should instead segment the art market into sectors based on price. It is mostly the segment of works worth above $5m that is experiencing a price surge. In general it is not advisable to invest capital worth more than 5% of your wealth into an art asset, so there is only a small group of millionaires, with disposable incomes above $100m, who are active in this field. In fact, I would argue that the driving force of this segment of the market is the concentration of disposable income into the hands of a few hundred global players.

This particular market segment thrives on income inequality and its destiny is not linked to the general state of the economy in any specific territory. Data collected by management consultant Capgemini show some correlation between the concentration of wealth and the state of this level of the art market. Wealth concentration has grown steadily in the past ten years with the exception of 2008 when the aggregate wealth of the super-rich fell to $32.8tn, $8tn less than the year before; 2008 was also the year when the crisis of the art market started. By 2010 the crisis was over for this specific demographic, and in 2013 the concentration of wealth was at $52.6tn, $12tn above the 2007 peak. The art market is following a similar path with roughly a one-year time lag. According to Tefaf’s Art Market 2015 report, the global auction market peaked in 2007 at €24bn worth of transactions, falling to €19bn and €13bn in 2008 and 2009 respectively and then recovering to €24.6bn in 2014.

An example might help explain this phenomenon. If you have $20bn, the decision to spend $200m on a painting is less onerous than the decision to spend $1,000 made by a person with a disposable income of $100,000. This logic is fuelling other markets as well, such as the production of mega yachts: what would have been considered a top-end boat in the 1990s is today almost an entry-level vessel, both in terms of size and price. In a period of low interest rates, art is more appealing as an asset to park liquidity into as it does not naturally depreciate as, say, boats, which can rapidly become obsolete due to technological innovation.

However, while this has meant more jobs in the yacht sector, the social impact of rising prices for a commodity that has already been produced (art), is benefitting only a very small number of intermediaries, probably less then a hundred.

Even for the major auction houses, selling art at this level has become a costly game, due to the strong bargaining power of consignors and the perilous practice of guarantees. Profit margins for the intermediaries are much higher in the middle and lower price segments, where standard fees apply and a larger number of lots are required to satisfy a broader demand. From a profit and social benefit point of view, selling 100 lots at $1m each is much better than selling a single lot at $100m; however, in the current sellers’ market, the big auction houses are forced to operate in the top segment by competition and for prestige, even sometimes operating at a loss, as cover lots attract consignments at lower price points.

The financial nature of transactions at the top end of the art market is further enhanced by the increased use of guarantees; between a third and half of the lots in the prestigious May evening sales in New York were backed by direct or indirect guarantees to the consignor, thus delivering the seller the best of both words: the potential of the auction mechanism to drive prices up and the certainty of a minimum price typical of private sales.

This comes at a cost for the intermediary: if the guarantee is direct, effectively it is selling a “put option” on the lot, thus assuming all risks and becoming a principal in the transaction; when it is decided to reinsure the guarantee with a third party, the risk is transferred but the profit margins are hit by fees.

There is a paradox here: guarantees can be seen as either a sign of confidence of the intermediary or a sign of bearishness of the consignor. In an upward market guarantees are often unnecessary, but when the crash happens, they amplify the negative impact, as occurred in 2008 and 2009. The amplification of the sales by the press and the general public is fuelling expectations in this vicious circle.

Trickle-down effect

On a broader note, there is some trickle-down effect of the record prices into the mid and lower price segments, as entire groups of potential buyers are priced out from the upper level and refocus their efforts on less expensive works. A similar dynamic is ongoing in the collectible car market, where it has become nearly impossible to purchase Ferraris from the 1950s and 60s, thus fuelling the price rise for the lesser 1980s models.

In conclusion, should the current buyers of art at record prices feel secure in their investments? The answer is complex: even if the art market does not crash, sustained by growing income inequality (as long as inheritance taxation does not change substantially and billionaires are allowed to shop around the world for the most favourable tax regime), works of art will remain subject to taste, and taste changes over time. The collectors of the Victorian period discovered this to their horror after the turn of the 19th century, when it became impossible to find buyers for the paintings they acquired for record prices a few decades earlier. In fact, as the Greek philosopher Heraclitus would say, we (almost never) swim in the same market environment: ten years from now the first half-billion dollar work of art might not be the same record price Picasso of today, but a new darling of the gatekeepers of the moment. We are witnessing an ongoing process of financialisation of the art market, a process destined to benefit a very small number of players, mostly outside the current structure of the art world, at the expense of many others. In the end, this may also compromise the deeper meaning of collecting and of art itself.

Giovanni Gasparini is the director of the Master’s course in Art, Law and Business at Christie’s Education, London