More on Lafite in China.

[randomness]

Back in August I linked to Andy Xie's column about Chinese demand for fine French wine, and those of Château Lafite Rothschild in particular. Now there's more news from the Wall Street Journal: "Decanter.com, a British wine magazine, ran a story on its website that Chateau Lafite Rothschild 2008 was to feature a Chinese symbol for the figure eight “in celebration of the First Growth’s new vineyard venture in China.”"

Decanter.com adds: "The symbol, which is considered especially lucky in China, will be on every bottle and magnum of Lafite 2008."

Mr. Xie has more analysis, just out today:

Summary

I wrote a few months ago on why Carruades de Lafite is a bubble, because it is misconstrued as the little brother to Lafite in China, similar but a bit less good. I thought that one could still make a case on skyrocketing Lafite price as revaluation due to new demand from China. What I have seen and heard in the past few months convince me that, not just Lafite, the whole fine wine market is a bubble. Like other assets, the force for the bubble is the low interest rate environment. Bernanke is a bigger reason for the fine wine price than 1.3 billion Chinese.

In the 2000 internet bubble, a lot of companies were worthless but were trading at billions of dollars of market capitalization. Some were really good companies but were priced several times higher than their intrinsic worth. Lafite is like the later.

It's never easy to call the top in a bubble. China's tightening due to inflation marks the peak for Lafite, I believe, just like for China property. What follows is sluggish trading volume and sideway prices. The crash happens when the US treasury market crashes, which forces the Fed to tighten monetary policy. That is probably in 2012. Still, now is the right time to sell your Lafite.

Lafite has outperformed

Gold price has more than quadrupled in the past decade. The price of 2000 vintage Lafite has done 100% better, up about nine times. By weight Lafite is more expensive than silver even for a bad vintage, and almost ten times as expensive for a great vintage like 1982. If the next decade is as good for Lafite as the last, for a great vintage it could become as valuable as gold by weight.

Moreover, Lafite has been resilient to shocks. It sailed through the 2008 financial crisis with merely a blip and began to make new highs before almost anything else. It has outperformed all other great wines by miles. For example, 2000 vintage Lafite came out for about the same price as Latour but goes for twice now. In the traders jargon Lafite is a truly alfa asset, i.e., it delivers loads of upside in a good market and but little downside in a bad market.

Wine performance isn't just about Lafite. After all the fine wine index-Liv-ex 100 has tripled in five years, even though the world suffered the biggest financial crisis in six decades in the meantime. Lafite has done 100% better. The fine wine market has done better than any major class of financial asset out there.

Wine drinkers become hoarders

Fine wine is an investment asset, because it can last for a decade or two with improving drinking value. But, the transaction cost is very high, like 10% transaction fee for turning over in the market. The storage cost is another burden. Even under the best storage condition some turn bad. Compared to other collectibles like paintings or antiques wine is more perishable. Hence, it can never be a main investment asset.

Fine wine could be a great speculative asset. The small volume from each chateau is perfect for some people to corner the market and create momentum to suck others in. The main hoarders are probably chateaus themselves plus wine merchants and, maybe, some Chinese speculators.

The top Bordeaux chateaus behave like internet companies in 2000. They sell a small proportion for each release. The shortage triggers market frenzy. They then sell more into it bottle by bottle overtime.

Wine merchants behave like investment banks in a bubble. They saw their buyers making a lot more than their commission and have become 'investors' themselves, like proprietary trading on Wall Street. Wine merchants nowadays sell wines like investment banks sell gold. The pitch usually starts with money losing value and ending with 'Chinese would buy from you at higher prices.' Overtime they believe their own story and, instead of selling to their clients, hoard themselves.

There are Chinese hoarders, especially from Zhejiang. The land price there has appreciated by about one hundred times in the past decade. Their view towards Lafite is different from other people's. When your main asset has appreciated 100 times, everything else seems cheap to you. Indeed, you may expect everything else to rise that much. Hence you become a speculator in everything else. The land price at home is the main force driving Zhejiang speculators.

Even wine lovers have become hoarders. They used to gather for a glass of fine wine. Now they talk about how much money they are making on their collections over a glass of bad wine.

The statistics on where all the Lafite are kept are impossible to get. My suspicion is that the above three groups account for most of the recent vintages, say, since 2005. The real picture will only come out when the bubble burst. When Bear Stearns and Lehman Brothers went under, the world realized that the banks kept much of the toxic assets at home.

The China factor

'When it goes down a government official's throat, the Lafite bubble just vanishes. No more bubble!' a Wenzhou Lafite hoarder recently responded authoritatively to the Lafite bubble talk.

Whenever an asset defies gravity for so long, millions of pet theories pop up to explain or justify it. In 1989 the explanation for Japan's high stock and property prices was that Japan had found a better economic model. In 2000 too much demand was the popular answer for the unusually high prices for internet stocks. The favorite theory for the high and rising Lafite price is China buying.

When it comes to China, everyone has a theory. China is big and opaque. Anyone can claim to be a China expert. And you can't disprove it. When it comes to a drinkable asset, 1.3 billion people come in especially handy for justifying whatever price. 200 thousand bottles of Lafite a year, 1.3 billion people drinking. Wow!

But why would anyone want to drink something for recreation that is ten times as valuable as silver and may become as valuable as gold in a decade? After all people are hoarding silver and gold? Could hoarding be a better explanation for the Lafite phenomenon? As Lafite begins to deteriorate after a decade or two, hoarding doesn't work forever. Hence, if this is the right explanation, the Lafite phenomenon is just a self-fulfilling bubble.

People who know China better will disagree. Chinese are crazy about Lafite. A friend in Guangzhou got a few cases of 2005 Lafite through a friend of mine. A few days back he called for more.

'The leaders drank it.' He complained

When Chinese businessmen treat government officials, Lafite is the choice of alcoholic drink. The popular drinking style is 'fill it up and bottom is up'. Quite a few businessmen have gone burst entertaining government officials this way. Some look for more cost effective strategies.

'After a few cases, I feed them fakes.' a businessman once remarked to me.

It is a high risk strategy. If found out, you may lose more than just business.

Money worship in Chinese culture sometimes manifests itself in money burning. People who become rich overnight in China are called gushers or mushrooms. Some mushrooms are so big that they want to burn money to prove it. One very big mushroom flew in Lafite in oak casks for a dinner.

'Today we drink Lafite like beer.' He announced at the beginning of the dinner.

China factor can backfire

China is the fastest changing country on earth, taste included. Chinese government officials change too. Cognac was the biggest deal for them two decades ago. Sharkfin soup was hot a decade ago. Lafite is today's darling. Who knows what lies down the road.

If I had a lot of Lafite, I would be selling.

The whole article is worth reading.

Comments

[cerebralpaladin.livejournal.com]

The really weird thing with this is that question of whether the fact that it's a bubble in a consumable makes a difference. I mean, if Lafitte produces 100 arbitrarily sized units of wine in year 0, and over the next ten years 20 get drunk by the normal wine consumption market, and 70 get drunk as parts of strange dynamics in China (wining politicos and the like), the prices on that last 10 units can go pretty high based on a real shortage--and over time the shortage gets worse. On the other hand, if the consumption pattern is more like 10 and 10 with 80 held as speculative investments, it's a bubble waiting to burst--there's a real glut on the market concealed by speculative buying, and when the bubble bursts the real glut will be revealed. It's very strange, especially when compared to bubbles in durables.

One other question I have is whether any of this can be explained in terms of capital controls and the like. If I were a wealthy national of China, living in China and with wealth produced in China, I would be desperate for opportunities to diversify and invest abroad. Capital controls make it quite difficult, as I understand it, to do so in a normal way: buy lots of dollars with my yuan, then use those dollars to get a diversified portfolio of stocks (and maybe bonds, REITs, etc.) in the international market place. So that then leads to the idea of using commodities as a bad way of diversifying: if I can't buy dollars but I can buy gold, I have some protection against the Chinese govt's policy of functional massive inflation. That makes me wonder if buying Lafitte is viewed as a way of investing in an internationally traded asset, thus gaining some protection against China's currency policy.

[r-ness.livejournal.com]

One other question I have is whether any of this can be explained in terms of capital controls and the like.

Oh, I'm sure that's quite a bit of it. The Louis Vuitton bags mentioned in the piece are another manifestation of this.

There's also some anecdotal evidence that high end real estate in foreign cities popular with Chinese--Vancouver, Sydney, Auckland, Singapore, Toronto--is getting spillover from the Chinese real estate bubble.

As for Chinese using wine as an inflation hedge, it's got two problems already mentioned in the piece: it goes bad, which gold doesn't; and its value is undercut by counterfeiting.

(It occurs to me now that there's probably a very strong black market in used Lafite bottles.)

[r-ness.livejournal.com]

I see Freaknomics got to that first:

Are Empty Wine Bottles on eBay Being Used for Counterfeiting?. (I guess it would be more accurate to say that Prof. Günter Schamel did.)

They also mention that there's probably a black market in corks, too.

[achinhibitor.livejournal.com]

If I had a lot of Lafite, I would be selling.

Short it!

[r-ness.livejournal.com]

As far as I'm aware, there's no easy way to do this. But if you find one...