Beware the perils of dabbling in contemporary art

Early in May each year, the art world descends on New York for two weeks of auctions. These are the most important dates in the art calendar and what happens at them generally sets the tone for the rest of the year. Deborah Brewster in the FT asks what was the message this year? In a nutshell, the art market in general appears to be slowing, but the "flaky" contemporary-art sector is not. Instead, it's the hottest ticket in town.

As evidence, consider the first sale of the New York fortnight - of Impressionist and Modern works at Sotheby's on 3 May. It was a disappointment. Only two thirds of the the works sold, bringing in a mere $91m. Then look at the recent reports out from Sotheby's and Christie's, says the Evening Standard. Both reveal that in contemporary art, the market is back to the levels it hit in 1989, the high point of the greatest boom the art market has ever seen. This kind of market division is a classic sign of a bubble, David Kusin, who has written two books on the global market for The European Fine Art Federation, told the Evening Standard. While a large part of the market is behaving relatively rationally, one specific area is getting out of hand and pieces are selling for prices that bear little relation to what has gone before. The first time this happened was in the mid-1980s, with Meissen porcelain. It burst and "that market never recovered".

But why is a bubble occurring in contemporary art? Kusin thinks it may have a lot to do with the generous annual bonuses on Wall Street at the end of 2002 and 2003. Christie's chief executive, Edward Dolman, might agree: he told The Times that "a lot of newly enriched young people", especially City dealers and hedge-fund managers, are turning to art purchases. Added to this is "phenomenal" demand from the Chinese, who are no longer just buying back their plundered heritage but pouring into contemporary art too.

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Hedge-fund managers are getting in on the contemporary art act, says the Wall Street Journal Europe. With their sudden riches and quest for status, they compete fiercely against each other for what they call "wall power" - trophy art in their offices. But this isn't a good thing; just as the flood of money into hedge funds has created new risks in the financial markets, now it has helped inflate a bubble in the art world.

Still, it's hardly surprising that young City-types are throwing money at art, says The Times. With their eyes on the rear-view mirror, they see that it can be a very profitable investment: consider Charles Saatchi. He bought Damien Hirst's petrified shark for £50,000 in 1991 and sold it this year for £7m. They can also see the art market as simply another market ripe for trading, buying, selling and flipping. Right now, art is relatively liquid, so investing in it is similar to playing the stockmarket, says Fiona McGoran in The Sunday Times. Note too that contemporary art as an investment has outperformed the larger art market in the past 25 years, as well as bettering most other asset classes, such as gold and 30-year Treasuries, according to research by New York academics Michael Moses and Jianping Mei.

But investors should be wary - the contemporary-art market is "notoriously fickle". Christie's recent contemporary and post-war sale set record prices for 17 contemporary artists, including Arshile Gorky, Sigmar Polke and Joseph Cornell. Investors should note the potential parallel between the high prices paid for unknown firms during the dotcom bubble and high prices being paid for artists with short sales histories, Michael Moses warned FT readers.

The art market is "like a giant pot-bellied pig, lying on its back, enjoying the excesses, but with little room left to expand", says Colin Gleadell in The Daily Telegraph. Indeed, investors need to be particularly vigilant at the moment, says The Sunday Times. The art sector is in the midst of a boom that might seem to hold potential for gains, but remember this market is as cyclical as any other. Any shock to the economy, such as another terrorist attack or rapid interest-rate rises, would leave the contemporary-art market vulnerable to a collapse.

Currently, it's a sellers' market. So one precaution buyers should take before investing is to study art indices, advises Bernard Williams, director of Christie's. Indices compiled by Art Market Research (AMR, www.artmarketresearch.com) are followed closely by investors. A look at the AMR Old Master 100 and AMR European 19th-century art shows both have fallen by 10% over the last year, while the value of modern and contemporary works has risen. Another useful index is the Mei Moses annual all art. It has plotted all New York sales since 1875.

"The main area where big money can be made is in the $100,000 to $3m area," says Philip Hoffman, chief executive of the Fine Art Fund, but "investors have to be careful and get good advice". Don't forget that eventually all bubbles burst.