Can the Party Continue?

 Everyone on the street has been agreeing on one idea: 2010 will be another great vintage, and the chateaux will be releasing at very high prices, similar to those of 2009. This has led to a rush of people stockpiling their "cellars" (whether moldy passageways beneath castles, state-owned warehouses in China, or Excel spreadsheets at hedge funds) with back vintages that appear to be good relative value. For example, a UK merchant recently sold through many cases of 2006 Palmer @ 1100 GBP/cs (RP 94) as it looked inexpensive in comparison to the 2009 Palmer (RP 94-96), which was released at 2400 GBP/cs.

While I've certainly been a beneficiary of this uncoordinated, collective market movement, I have another view regarding the 2010 en primeur campaign, one that nobody wants to talk about. I believe it will suck so much cash out of the wine investment economy, that no one will want to buy more Bordeaux again for a while, thereby limiting the short-term upside of prices.  In the long-run, there is also a problem: the one where every vintage is a new "vintage of the decade."

Whereas great wine used to be predominately determined by the weather and the idiosyncrasies of each individual French producer, these days, technology plays an increasingly important role. Disastrous years simply don't happen anymore because the technical knowledge is much better across the board. And with the current levels of revenue at stake, everyone in the Old World  is investing in technology.

But maybe the bulls are right about China. And by bulls, I mean everyone. Maybe there will just be enough billions injected into the wine market by mainland Chinese, supplemented by the emerging markets of India and Brazil. Things, however, don't stay cool forever, and the elasticity of demand changes over time. We've seen Japan and Russia walk away, and America finding substitute goods in the Russian River Valley.

I'm also skeptical about this recent boom in the Bordeaux Second Growths. "Demand in the Far East is broadening," says the street.

I will bet my left testicle it's not consumption demand.          

I know many well-off Chinese people who have lived in the US/Canada for decades who couldn't tell you the name for the "Bull's horn bun" that they used to eat in Hong Kong. (It's "croissant," by the way.) And so, I have a hard time believing that after a couple years of interest in wine, that there will be long lines forming at Zhejiang wine shops with people clamoring for, "more Ducru Beaucaillou, please."

But what IF, it's entirely investment demand out there? Assume 100%. And assume that 100% of "investment" is "speculation." Can a Chinese sell-off cause a crash? Not really. Because there is a pervasive problem of fakes in China, there will be no re-exporting. No merchant in the world will buy wine that has set foot inside the mainland. So if Chinese demand should taper off, I think it will first lead to stagnation in the UK market, followed by a gradual readjustment of release prices from the chateaux. A parallel exit by Western investors might take place, especially if interest rates creep back up. A dramatic bubble explosion it seems, would require a global financial crisis of the variety we saw in late 2008. But I would not be surprised to see immediate panic, if a credible rumor surrounding, say, Hong Kong's alcohol import tax, were to surface.

While I believe that these macro factors should make one weary of buying into the generally accepted types of wine portfolios, there are still creative opportunities for wine investment that over a long-term horizon remain less sensitive on the downside to sudden shocks, and in my view, an attractive alternative asset class. I'll talk about these in a future post.

- Pinotchio, CFA level 0.