Monday, June 10, 2013

What's it worth? Valuing unique specimens (part 1)

When I was an undergraduate, I took a course in Macroeconomics. This is the study of How Money Works, nationally and internationally (and is no help whatsoever for balancing a check book). One learns early that money is not a fixed quantity--that it can be created and destroyed. One also learns that money is a medium of exchange, and not an innate measure of value.

Instead, prices are set by supply and demand. When a commodity is widely available compared to the demand for it, prices are low. When a commodity is scarce and people want a lot of it, prices go up. For many gemstones, for which size and quality can be specified, prices are stable enough that price lists are useful for relaying market prices.

But what about unique items? If there is considerable demand, the selling price may be very high: more than $33 million was bid for a particular Oriental rug, as a recent example. And if demand is nonexistent, the price is irrelevant: in that case, the value might as well be zero.

Appraisers and insurers use the term Fair Market Value (FMV). The IRS defines FMV as: "the price that would be agreed on between a willing buyer and a willing seller, with neither being required to act, and both having reasonable knowledge of the relevant facts" (from IRS publication 561,

In practice, it is commonly recommended that rare items can best achieve their FMV at auction. However, auction prices for individual items may not be representative for various reasons. Perhaps the auction was not widely advertised to interested parties. (One I attended in the 1980s occurred during a snowstorm, which enabled me to get some excellent mineral specimens at very reasonable prices.) Conversely, sometimes bidders get over-excited--or over-competitive--and certain items are bid to astronomical prices. (Charity auctions are a likely place for this behavior.) Because of these factors, I sometimes say that prices at auction indicate how much the person who wanted an item second-most was willing to pay: that is, the highest losing bid sets the value. On a case-by-case basis, the market may behave irrationally.

Of course, the solution to this is to look at many examples, not just one. Consider the appraisal of houses Perhaps you live in a century-old house that is rather unique. There are no exact comparisons--in size, location, age, construction, view, landscaping, distance to schools, etc.--currently on the market that would set the value for this house. So a real estate agent, or insurance appraiser, or tax appraiser, does not look at every factor that sets the approximate value of the house. Instead, they consider certain basic factors -- neighborhood, house size, lot size, etc. to set a value; and use the other factors that may make the house unique -- a remodeled kitchen, a view, general condition -- to add or subtract a premium to that base price.

How does this apply to appraising mineral specimens? See Part 2, to come at some point....

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