Price of scarcity: Central banks are driving large valuation premiums on assets with limited supply

By Charles-Henry Monchau, CIO at Syz Bank

It is important to understand the concept of scarcity to better understand its mechanics and its impact on markets. Scarcity refers to the mismatch between a finite supply (resource) and a theoretically unlimited demand. Supply is therefore a key factor in determining the degree of scarcity of a good or asset, but demand also plays an important role. The relationship between supply and demand is well known in microeconomics as it is used as a model for determining prices in markets. In the case of so-called scarce goods or assets, a limited supply and a high demand mechanically translate into higher prices.

The business models of some companies are based on the principle of scarcity. Let’s take the example of luxury brands. Their limited supply combined with the high desire of consumers to experience or own a brand allows manufacturers to practice a high pricing policy. And even more than that, since certain Swiss watches (Rolex, Patek, etc.) or Hermès bags have become real speculative assets that seldom depreciate (if intact).

Over the past 12 months, the sharp rise in inflation has only increased the appeal of these so-called “scarce” goods and assets. Many experts do not hesitate to make a link between this craze and the massive flow of liquidity injected by central banks following the coronavirus crisis.

Post-2020 recovery benefits scarce assets 

We distinguish two types of scarcity effects at this stage of the economic recovery.
The first type affects assets, goods and services that are suffering from a temporary supply deficit. Indeed, the 2021 inflation spike can be explained not only by a much stronger-than-expected recovery in demand, but also by bottlenecks in transportation, supply chains, labor, and supply shortages of some commodities, in the energy sector in particular. We expect this scarcity effect to be resolved by 2022.

Take the case of second-hand cars in the US. The shortage of semiconductors has led to latencies in the supply of new cars but also to higher prices, which has caused consumers to rush to used cars.

The Manheim index of used cars in the U.S. has risen 50% in 2021, due in part to a speculative frenzy in second-hand cars, with some now viewing used cars as financial assets and anticipating a continued rise. We do not believe that this type of asset will benefit from a scarcity effect in the long term, as car production possibilities will be almost infinite the day the supply chains are running at full capacity again. We also believe that the labor market, energy and transportation sectors should soon return to equilibrium.

On the other hand, there are some assets and sectors for which the imbalance between supply and demand is bound to remain perennial. We include in this category luxury real estate, especially in locations where construction possibilities are very limited. The sharp rise in the number of millionaires (+7% per year) and very competitive mortgage conditions have caused prices per square meter to skyrocket in high-end ski resorts (Gstaad, Verbier, Courchevel, Aspen, etc.) as well as in cities and towns favored by the wealthy (Geneva, Zurich, Monaco, London, Hong Kong, etc.). Prices in cities where the supply of property remains abundant (e.g. Dubai) have not experienced the same trajectory.

Other assets for which scarcity should continue to be synonymous with high prices are vintage cars, the art market, collectibles and luxury watches. Last month, a Patek Philippe Nautilus model with a Tiffany blue background sold at auction for $6.5 million, while this model, limited to 170 pieces, sold for $52,000 in stores a few days before… For such assets, the cocktail of “limited supply, abundant liquidity and rising inflation” should remain explosive.

Precious metals such as gold and silver also possess the characteristics of a store of value that is favored at the time of inflation and liquidity abundance scenarios. Although they have not performed up to expectations in 2021, this type of assets could soon be back on the “radar” of asset allocators.

It is interesting to note that the saying “what is rare is expensive” also very much applies to the equity market. This is the case, for example, of certain luxury stocks (LVMH, Hermes, Richemont, etc.). Let’s also remember that the exceptional dominance of the famous FANGs has caused their valuation multiples and market capitalizations to explode.

Below, we would like to focus on three themes whose scarcity aspect could positively contribute to their market performance: 1. Industrial metals needed for the energy transition; 2. Uranium and 3. Crypto-currencies.

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