Are rare coins the new value investment?

The market for rare US coins is not one a casual investor would first consider, but in terms of pure performance numbers, it might be worth a look.

According to the Numismatic Investments Corporation of Lisle, Illinois, there are currently "significant price inefficiencies" in the rare US coin market, to the extent that the firm is trying to provide investors with a structure that will allow them to profit from this. NIC is in the business of carrying out extensive and ongoing mathematical modelling of US coin series to identify prospectively undervalued rare US coins. The firm sells portfolios of US rare coins called K-Score Portfolios, based on predicted performance relative to the coin market. Each portfolio is unique, and tailored to individual client investment preferences and choices. NIC does not hold an inventory of coins itself, but instead buys them on an order-by-order basis.

"After an extensive research effort we identified a considerable number of investment grade coins that are prospectively undervalued," says Gary Knaus, president and CEO at NIC.

Prices for coins his firm has identified as undervalued have increased by 13.4% over the past eight months (to July 2006), whereas the PCGS3000, the widely followed rare coin index, rose only 5.28%. "This finding highlights the potential for above market returns to investors seeking the benefits provided by rare US coins in a well-diversified investment portfolio," Knaus said.

There are a number of documented benefits to investing in rare coins, or to keeping an allocation to coins in an investment portfolio, including increased returns and reduced volatility. Rare coin returns are also negatively correlated with interest-rate sensitive investments, and inversely related to equity returns on a 10-year moving average basis.

The long-term returns on US rare coins investments have been nothing short of spectacular. In 1970, if you had invested in a portfolio of DJIA stocks, and a portfolio of rare coins, your coin portfolio return would have exceeded the DJIA by more than 400%. Even over shorter investment horizons, rare coins typically perform at a level comparable to equities while providing both tangible asset diversification and reduced portfolio risk.

NIC recently discovered what it calls a "trough-like" relationship between the CPI and rare coins returns. During periods of high inflation, as well as periods of deflation and low inflation, rare coin returns were exceptionally strong. "This market is attractive for several reasons, not the least of which is that rare coin prices are 63% below their 1989 watermark high," Knaus says.

Factors that are driving interest in the market include a history of growth, excellent returns, high liquidity, independent coin certification services, opportunities for US investors in particular to benefit from 1031 tax-deferred exchanges (this allows investors to swap appreciated coins for prospectively unvalued coins without realising a gain at the time of exchange), and an estimated $40bn of rare US coins in particular held by between four and seven million collectors and investors.

Over the last three decades, the US coin industry has transitioned from a 'mom and pop' market with fewer than 100,000 participants, to a multi-billion dollar industry with 20,000 dedicated dealers serving a market in the millions. The current value of rare coins held by collectors and investors is estimated by the American Numismatic Association to be $40 billion.

The market also benefits from limited supply. It is generally accepted that upwards of 95% of original mintages were lost due to mishandling or melting. The small surviving population of coins forms the backbone of the investment market for rare US coins. With the vast majority of surviving rare coins having now been certified, it is estimated that there are fewer than 7m investment grade rare US coins in existence. Unlike most other tangible assets and collectibles, certified coins have high liquidity that is provided via the dealerships as well as two independent electronic trading networks - the Certified Coin Exchange (CCE) and Certified CoinNet. These trading/information services are independent of each other and have no financial interest in the rare coin market beyond the service they provide. For example, on a typical day, the Certified Coin Exchange has bids outstanding for $800m in certified rare coins.

Beginning in 1986, the market in rare coins became more investor attractive with the creation of nationally recognised, independent certification/grading services. These companies do not buy or sell rare coin products. They are independent third party services whose sole function is to certify authenticity, determine grade, and then encapsulate each rare coin. Coins are sonically sealed in a hard plastic holder with the appropriate certification and bar coding information sealed within, which creates a unique, trackable item. This encapsulation serves also to preserve the coin in the same condition as when it was certified.

Further excitement was generated by an article by Robert Brown (CIO of GE Private Asset Management) in the Journal of Financial Planning, which claimed that over the last 62 years, rare coins offered an annual arithmetic mean return of 10.46% and an average geometric mean of 9.83%, which compares quite favourably to a portfolio of growth stocks over the same period.

Rare coin portfolios, like the ones offered by NIC, are not for everyone. As a rule of thumb, tangible assets should not exceed 5-10% of investable assets. "Given a recommended minimum portfolio size of $50,000 and a suggested five or more year holding period, this would limit customers to accredited investors or those nearly so," Knaus says.

Since fewer than 10% of certified rare US coins qualify for inclusion in a K-Score Portfolio, only a limited number of portfolios can be filled each year. NIC does not offer its coin portfolios directly to the public. "We prefer to work with and through financial professionals to ensure that potential clients are properly qualified," says Knaus.