Investing in Hard Assets 

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Investors should pay close attention to the children’s story of the three little  pigs. When one little pig built his house of straw and the second little pig built  his house of sticks, they both became tasty dinners as their houses collapsed  under the big, bad wolf’s onslaught, but the third little pig’s brick house stood  undamaged and he was spared the unfortunate fate of his brothers. 

There’s a lot that investors can learn from this fable. Investors often act like pigs, suspending common sense as greed and carelessness control their  decisions. They build fragile portfolios of insubstantial “paper” financial assets  that can quickly succumb to the wrath of a very different animal - the bear. The dot-com bear market of 2000-2002 wiped out as much as 80% of many  stock speculators’ wealth. The sub-prime mortgage meltdown of 2009-2010 also  devastated stock and bond portfolios. Investors learned too late that “paper  assets” such as stocks, corporate bonds, even currencies are merely derivatives  of something else and can have little or no intrinsic value (how much is a piece  of paper really worth?). These assets represent a promise to pay (bonds), a  share in a company (stocks) or a government-controlled medium of exchange (fiat currencies). To make matters worse, the supply of such assets can often  be increased simply by turning on a printing press, diluting and decreasing their  market value. Furthermore, the demand for paper assets is volatile because in  times of trouble or uncertainty, nobody really needs stocks or bonds. 

In the interests of diversification, it’s smart to put money into “hard” (or  “real”) assets such as precious metals, commodities, fine art, collectibles and  real estate that have utility and intrinsic value. Their supply is limited (you  can’t make any more Rembrandts or ocean-front land) and demand is often  substantial. Some hard assets are necessities, such as homes – everyone needs  a place to live. 

There are several other reasons why hard assets appeal to investors. For one  thing, they are not currency specific – that means that because they have  global demand, they are priced in many currencies and when the value of one  currency changes with respect to another, the price of the asset adjusts to  equalize the valuation disparity. So if gold is priced in dollars and euros and the  value of the dollar falls with respect to the euro, the dollar price of gold will  increase to make up for the depreciated buying power of the dollar while euro  price of gold remains essentially the same. 

Also, many hard assets are transportable, which means they can be moved to  places where they command a higher price. Price disparities are thus relatively 

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easily adjusted. If a commodity such as corn is priced low because of a glut in  one market, it can be shipped to a place where it is scarce, bringing a higher  price. Shipping the corn elsewhere causes the supply in the region with the glut  to diminish and the price will rise, with both markets tending toward price  equivalency. This helps cushion the price of transportable hard assets from the  effects of a declining currency or local inflation since it is priced in other  currencies as well. 

How does the real estate market compensate? Real estate is obviously not  transportable, but real estate is constructed from a wide range of commodities  that can be transported, such as lumber, copper, cement, appliances, etc.  Since a large part of a house’s market value is the sum total of the cost of its  components, real state has significant protection from the economic conditions  that can undermine stocks, bonds, currencies and other paper assets.  Furthermore, the land on which the house is built is a valuable hard asset in  limited supply that can never be destroyed. When an area is fully built and  there is little available undeveloped land, land prices increase as demand  outstrips supply. Also, since real estate is very labor-intensive and wages tend  to increase, the labor cost component of houses also rises, adding additional  upward pressure to prices. One thing is certain – builders will not build houses  that they can’t sell for a profit. When their costs go up, their prices must go  up. And since home buyers consider existing homes as well as new homes,  when new home prices rise, demand shifts to existing homes, driving those prices higher as well. 

Another characteristic that makes hard assets attractive to investors is  possession and control. Paper assets are volatile, unpredictable and risky in  part because investors have little, if any, control over their management or  operation. Corporate stock, for example, may represent a partial ownership  interest in a company, but an individual investor has no control over the  operation, earnings or dividends of the business. The investor pays his or her  money and then just hopes that management will be responsible, honest and  capable in enhancing shareholder value. If that is not the case, or the stock is  in a bear market, the value will likely go down and the investor can do nothing  about it. However, ownership of a hard asset such as precious metals or real  estate gives the owner possession, management, control and leverage. It is a  direct investment, not a derivative, and therein lies its appeal. Furthermore,  should rental real estate experience a temporary price decline, income from tenant rents give “staying power” – the ability to wait for a resumption of price  appreciation without running out of money to hold the property. 

When committing hard-earned funds to an investment, hard assets are an  excellent choice for a significant portion of your portfolio. Think of this: How  many people do you personally know who made a fortune as their stocks  appreciated and how many made a fortune as their real estate appreciated?

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