Friday, October 10, 2008

Gold, fine art and collectibles...

I have always been deeply skeptical of investments in non-cashflow generating assets (gold, fine art, collectibles), where value is almost entirely driven by perception.  However, a crisis like the current one illustrates why these types of assets continue to have a hold on investors. When investors lose faith in financial assets (and the authorities and entities that back up those financial assets), they look for physical and tangible investments to buy that they can hold on to. Real estate used to be the investment of choice, but as my last posting indicates, real estate is behaving more and more like other financial assets. There is always gold, the fall back in every financial crisis in history, but the net actually has to be cast wider. I would not be surprised to see other collectible assets, including Picassos and baseball cards, go up in value.
Having said that, I still believe that these are terrible long term investments on their own. After all, an investor who bought gold in the early 1970s and reveled as the price of gold rose to $ 1000 in the last 1970s would have made about 3% a year for the last 30 years on the investment. The best role that I can see for them is as ancillary investments in a larger portfolio, where you accept that the expected return on the investment will be low but you are willing to invest in it anyway as insurance - against inflation and crises. Do I wish I had gold in my portfolio now? Of course! Am I going to sell everything that I own and buy gold? Of course not!

9 comments:

evileconboy said...

Professor. Can you re-do the S&P Dividend Discount Model valuation you did in class a few years ago?

My friends all ask me, where is fair value for the S&P? I tell them it's a factor of the risk premium (easy to calculate) how much de-leveraging will happen across companies (speculation), what the return on capital will be (assume historical average), and what the dividend payout policies will be.

What is the current pricing of the S&P saying about what the market thinks?

imtiaz said...

Dear Sir Damodaran,

What do you think the effect of global slow down on the emerging markets like China and India where people save more and invest less vis à vis USA?How can a small investor safe himself from the type of crisises that prevail today?(This question is purely in the context of valuation).

Aswath Damodaran said...

I revalued the S&P 500 with lower cash flows for the next year or two, a higher equity risk premium of 5% (I have generally used 4% in my valuations) and the estimated value is about 1100. You can make your judgments about whether you believe this valuation or not. I still think a far better bet right now is to focus on individual companies in the S&P 500 that have become severely under valued and buy them.

BT said...

Hi Professor,

I did a simple valuation of the S&P assuming stable growth which came out with a value of a little over 900. Would you mind sharing your thoughts on my assumptions?

Here is my work: S&P dividends and stock buybacks have averaged $400M / year for the last 9 years. I assumed this is the cycle-adjusted value of payouts. Then I assumed beta of 1, long term growth = risk free rate, and an equity premium of 5%. Under those assumptions, the value of the S&P comes out to $8 trillion, which is just a shade higher than where it closed on Friday (899 index, and value of $7.9 trillion).

Would you share any thoughts on these assumptions?

BT said...

Sorry, typo above: I meant payouts to shareholders have averaged $400B per year, not $400M =)

Aswath Damodaran said...

The current implied equity risk premium is about 6.3%. If the true risk premium is closer to 5% (and I think it is), the S&P 500 is significantly under valued....

BT said...

Thanks for the response. I guess the difference in valuation all hinges on the assumed future cash flows. If the implied ERP is now 6.3% then it seems the assumption for future cash flows is higher than $400B for the ERP calculation. Or am I missing something?

Given how wildly the market is swinging, it seems people keep changing their mind about the future cash flows and the ERP =)

dharma said...

dear professor
I do agree with u that gold hasnt given astronomical returns over the last few decades. But given the response to this crisis (which is going to manifest itself over multiple years) in the form of printing currency to pump prime the economy back into shape, dont u think gold will be much sought after by central banks in future(maybe years later) to restore the value of worthless paper currencies

Jennifer Akre said...

While investing in gold, it is important for a gold investor to understand the current and historical gold price. Also it is important to know well about gold price chart. The crisis related to gold prices seems to be increasing day by day.