The Lafite Puzzle

[JimHow]

An interesting article that Rick Julien forwarded to me from The Big Picture:



The Lafite Puzzle

Posted: 17 Aug 2010 07:10 AM PDT

The Lafite Puzzle
ANDY XIE

>

China’s impact on the luxury French wine market has been enormous. The French fine wine index (Liv-100 index) is up by roughly 37% from a year ago, 24% year-to-date, and its upward momentum remains strong.

Not many asset classes have hit new highs above their mid-2008 levels. In addition to fine French wine, gold and China’s residential property sector reached new highs in 2009. But I can’t recall any others. And among the three, French fine wines seem to have performed best.

There is little doubt that Chinese buyers, not Wall Street traders, are the force behind this positive trajectory for French fine wine. Bordeaux wine producers are all talking about China and Chinese buyers seem to dominate the en premieur for the 2009 vintage available from next year. In fact Chinese mainland buyers are increasingly pricing out buyers from Japan, Taiwan and Hong Kong in the quest for ‘first growth’ wines.

French wine is, of course, different from a Louis Vuitton bag. When you drink a bottle of wine, it is gone. You can store it as an investment, but the process is complicated and costly.

For most Chinese, investment is actually a secondary consideration. Drinking it now is more important. Yet this seems inconsistent with the dominant Chinese preference for accumulation. So the question is, why so much demand from China?

Like Japan in the 1980s, an important factor seems to be the need to lubricate business relationships. This phenomenon plays out across the world during rapid economic development. Successful economic development may require a little intoxication – when one sinks a lot of money into an under-developed economy, it needs courage.

The business drinking culture has been changing in China. Like elsewhere, liquor consumption (like baijiu) has been declining out of health concerns. So the need for alcohol in business entertainment has produced a unique Chinese phenomenon: massive demand for Chateau Lafite wine. Lafite is one of the five first growth wines from Bordeaux. France classified Bordeaux wines into first to fifth growth in 1855 for its World Expo. At that time four chateaux – Lafite, Latour, Haut Brion, and Margaux – were classified as first growth. In 1975 Mouton also qualified. The chateaux in some of the Bordeaux areas like Pomerol and St. Emilion do not participate in this classification system and have started their own, with some of their wines even more expensive than the five first growth wines. Nevertheless, the first growth label travels well, especially to a new market like China.

Among the first growth wines, Lafite has taken on a life of its own, rising much quicker than the fine wine market as a whole, and other first growth wines in particular. For example, 2000 vintage Lafite has appreciated by about 550% in pound sterling since 2005, compared to 180% for the market as a whole. The most comparable wine to Lafite is Latour, and the price of its same vintage has risen roughly in line with the overall market. The price differentials between Lafite and other vintages of first growth wines are not as dramatic as for the 2000 vintage, but they are still large. Something special has happened to Lafite these past few years. That something is China.

Essentially, Lafite has become the unofficial Chinese wine for business entertainment. There are theories as to why, the most popular being that the Chinese translation is easy to say and sounds nice. I am not sure this is the best explanation. Drinking at business events in China is not really sophisticated; it is more about getting tipsy quickly. Guests are expected to be impressed by the price of expensive wine, and not the taste.

Is the Lafite phenomenon a bubble? As Greenspan has said, one can never be sure if a bubble exists until it bursts. It is possible that Chinese drinkers appreciate something in Lafite that other drinkers never did. Hence, as Chinese become richer and spend more on wines, Lafite benefits from this source of demand more than others. So the Lafite phenomenon may actually be a price revaluation, rather than a bubble.

An alternative scenario could be that other first growth wines will get the Lafite treatment over time. Chinese demand for Lafite is due to lack of knowledge about alternatives, so when Chinese drinkers become more sophisticated, the demand for other first growth wines will probably increase. This could be a rising tide that will gradually lift other fine wines.

The second scenario is possible, and it has to do with the French system for wine production and the laws that make it impossible for the great wine chateaux in Bordeaux to increase production. Bordeaux wine producers have to go for quality and high price rather than quantity. Hence, when a new source of demand comes, the price always goes up.

Indeed, the Lafite price is now so high that it has led to a large counterfeit industry. Some analysts estimate that 70% of the Lafite consumed in China is fake. I have personally experienced this on a few occasions, although the people who served me fake Lafite were unaware of its questionable provenance because they paid the same high price fetched by the genuine article. I could tell that the fake was good wine too, probably a good second growth poured into a Lafite bottle. Forgers have targeted the legendary 1982 vintage in particular. Many wealthy Chinese have bought large stocks of 1982 Lafite and the odds are most of it is fake. There are so few bottles of the real vintage left that it is highly unlikely to find several cases of the real thing.

When the Chinese economy matures in ten or 15 years and business entertainment declines in importance, Lafite prices may come under pressure. At this point demand will be mostly for self enjoyment and hence, more price sensitive. Japan has already gone through such a cycle.

A market is efficient when informed consumers make rational choices. An efficient market motivates producers to improve quality and control costs and this cycle leads to great brands that last.

The French wine market was like that, but I am afraid that Chinese demand is decreasing the market efficiency and may bring down great brands over time. When winemakers see prices resulting from propaganda, not quality, they will focus on marketing and decrease their investment in improving quality. It would be a tragedy if Chinese demand, by bringing easy money, brings down a French legacy that has lasted for five centuries.

~~~

Andy Xie is a former Morgan Stanley economist, now living in China. This was originally published in China International Business Daily on August 17, 2010

[stefan]

I thought the reason the Chinese are buying up all the Lafite is that Lafite is the best wine for Peking duck. Live and learn.

[Houndsong]

"the Chinese translation is easy to say and sounds nice"

I'm not a linguist by any stretch but what is the Chinese translation? At least, phonetically, do they not call it Lafite? Or do they translate it into "Golden Cloudless Pleasure Dome of Happiness Wine?"

[JonoB]

I think our Andy here has very little clue about wine, and not much more about how mainland China works. Also calling Japan a mature Market is a phalacy as well. He may be right about bubbles, and the Chinese wanting to learn... I know people from Hong Kong who want in on this and are utterly clueless about how to do it, and others on the mainland who realise they need to speak to specialists but want to do it in their own way and not just drink Lafite.

A lot of 'this is wot I is herd on da grapevine soes it's must bes truff init?' in that article.

[JimHow]

I'm not an economic guy but I was actually was a little surprised when I saw the news this week that China passed Japan as the second largest economy-- for all the mega-growth in the Chinese economy, their economy is still like only half the size of the U.S. economy, even though their population is what, five times the size of ours? Their per-capita GDP is still one of the lowest in the world. Is China still basically a third-world country? And for all the noise about Asia, isn't the U.S. still the Godzilla in the room when it comes to French wine? Man, the United States is some kind of phenomenon in the history of the world, isn't it? (I'm not saying this in any American bragging way, it just seems to me the United States phenomenon-- its economy, culture, government-- with all its good and bad-- is really something....) I guess the point I'm trying to make is that, despite all the talk about Asia when it comes to French wine, I'm wondering if the old U. S. of A. still isn't by far the dominating force. (Again, I don't want our friends from other parts of the globe thinking that I'm making some obnoxious American statement here, it just seems to me that the U.S., despite all its problems, is still the enormous economic force in the world of wine, not Asia... I mean, for now, anyway.) I mean, for all the talk about China, its economy is still only half the size of the U.S. economy, with four or five times the population.... I realize that's going to change and it's just a matter of time before China takes over, but here and now, in 2010, is the impact of Asia on French wine markets somewhat overrated? I'm curious what others think, and, again, I hope this question doesn't get misinterpreted as some big God-Bless-America statement, I just wonder what the reality is out there. We hear a lot of anecdote, but in the end mighty China's economy is still only half the size of ours. With 1.5 billion people, shouldn't they have the largest economy?

Is China overrated?

[DavidG]

JIm, you have a valid point. When it comes to individual purchasing power for consumer goods like wine, personal income is more important than GDP. China may have passed Japan in GDP, but the average annual income there is still in the dumper. The problem with a statistic like average personal income, however, is that it doesn't tell us anything about how many Chinese gazillionaires there may be who might be interested in buying fine wine. With so many people dragging the average down, there could still be enough rich Chinese to soak it all up. I said could be... we just don't know.

[Comte Flaneur]

The Chinese are a suspicious bunch and Lafite means 'on the way up'

Is China overrated? yes and no...per capital GDP is only $6600 according to the CIA compared to $46k in the US (11th in the world, China is 128th)

The Chinese growth model is based on peasants moving from the farms to the factories where they can produce multiples of what they produce on the land...this will continue for the next 20-30 years (another 400m people to go), which means China can grow 8-10% real and perhaps 10-13% nominal per annum....the US is growing about 2% real and 4% nominal...so compounding those growth rates it wont take long for China to overtake the US in overall GDP terms...in per capita terms it will take a lot longer

China already consumes more Lafite and buys more cars than we do

[JimHow]

You are indeed right, David, last I knew there were over 200,000 millionaires in Hong Kong alone.

[stefan]

...and if each one buys one bottle of Lafite every year, then there are no bottles for the rest of us.

[JonoB]

Luckily in Hong Kong they still know about as much as the mainlanders but drink Lynch Bages instead. They like to be different.

I think a lot of people are misinterpreting (a) how those millionaires affect the wine market. (B) what they are buying and (c) a lot of the figures regarding China are completely false, because the minister will get the sack if the figures aren't increasing. You have to take some Chinese figures with a pinch of salt. In terms of the country that will make a real change to the wine market as a whole is India and not China (who just want Lafite).

I would like to make it clear that my background is socialogy and politics, and am not looking at this impact as Economic, because it isn't anything to do with economics. Japan is still lagging behind in terms of wine consumption based on these parameters.

Onto the Economics... if you actually see the real China and not what the government wants you to see... if China doesn't overtake the USA, they will have huge problems socially and that will lead to problems for the government. From what I can see, China will fall by the wayside and won't ever overtake the USA. We also seem to forget that most of the Chinese economy is based on export and not domestic consumption... that foreign investment can easily decide to move, and I've had arguments with people about the amount of government debt from the USA that the Chinese own, and if the shit hit the fan and USA defaulted... what can China do? Go to War? Me thinks not... they'd cause more trouble and lose more than they gain.

I agree, the USA is bizarre, bizarre in many ways... and I think their key is that major wars have never been fought on their own soil... slow, progression without hiccups. No boom and bust over the longer term in comparison to the War Economies of Europe.