In one of our previous articles, “Wine investment, what Warren Buffett would do”, we announced we would elaborate on the prevailing uncertainty in the fine wine market and shed some light on short term demand.
We have repeatedly commented on the fundamental health of the fine wine investment market. We believe there are many reasons why fine wine continues to make a good investment. Following, we also think the current lull in prices – caused by short term supply and demand issues and extreme macro-economic uncertainty – presents an opportunity.
The potential of the current situation in fine wine
Firstly, as covered on the blog, the fundamentals look good.
Secondly, a major reason for the current fall in prices is oversupply in China. It will take time for that to resolve itself, but as demand is still there, this in the end is a temporary factor, not a fundamental one.
Thirdly, war chests are building up. Because the fundamentals are sound, there is a “wall of money” waiting to be employed – as commented on in the previous post. Waiting for the right moment. The people managing this money can see the opportunities coming and they prepare themselves to take advantage of them. Why do we think this is the case?
- The long term average return on fine wine is very compelling, particularly in combination with the relatively low risk.
- The fine wine market is on course to become much more professional and efficient, which will attract more money
- Fine wine has to an important extent become an investment market. Participants – wine funds, collectors and big merchants – will act to make a profit if they see an opportunity.
- Any significant upsurge in demand will lift prices as the fine wine market is small (only £4bn per annum). Potential demand is infinitely bigger than supply.
Signs of the market turning
In addition, being involved in trading wine every day, we see more and more signs that point towards prices bottoming out:
- There are less good deals to be had – sourcing well is becoming difficult.
- More and more people are predicting when and where the bottom will be
- Indeed: the first players are stepping in. There are wines that are being picked off. There are also large outstanding orders to be filled.
- Not all is going down – Burgundy, Yquem and some Italians being a case in point.
So what needs to happen for this money to be put to action? In short, a sense that the bottom of the market can be called. Since fine wine is more and more behaving like financial markets, this has all to do with uncertainty. One major driver of uncertainty is what “our friends” in Europe do.
In “normal” economic circumstances, fine wine is not really correlated to the various economic and financial gauges or asset classes. However, in times of financial stress, all asset classes become very closely correlated. Here’s the point: once the markets find their bearings again, fine wine will become less correlated again and is expected to do well. The wider economy might well languish for a sustained period of time, but that might actually play into the hand of fine wine investment, which after all is an alternative investment.
On Europe – it’s all about uncertainty
For 2 years now, the Eurozone crisis has been moving towards crunch time/end game. Forget all the talk and even financial market demands. After all is said and done, if you strip it down to the core, the problem is that the euro-zone is made up of countries that are not equally efficient. In producing goods and services, and in running their countries budget. This would be fine if these countries had their own currency as that would act as a stabilizing mechanism. Inefficient countries would still be able to compete, because their currency – vis a vis their more efficient competitors – would depreciate, making their output more affordable and competitive. But they don't, they share the same currency.
Europe, on the 9th of December, has finally and for the first time, made moves towards a fiscal union. Right from the word go, at the Maastricht treaty 20 years ago to the day, we all knew that was required to make a monetary union (one currency) work. Therefore, the 2 year old crisis seems to have turned a corner. From now on, we’re talking about the real stuff and there’s no hiding.
Which makes one think about the next phase. What will happen to the less efficient Eurozone countries? On country level, overspending is no longer an option, they’ll have to live within their means, no short cuts. On company level, how is a Greek battery manufacturer going to compete with its uber-efficient German competitor? Let’s face it, he’s not. There is no way the Greek will be as efficient as the German. With all due respect, it’s just not going to happen. Given they share the same currency, the only escape is to become more competitive, by lower wages and very likely increased unemployment. Which will be painful and quite possibly unsustainable, as that would put the onus back onto the government, who now don’t have a way out anymore.
Were Greece isolated from international capital flows, it could work. But they’re not. Lower wages, in the face of prices of a lot of products being set outside of Greece would lead to real loss of disposable income. Recession would be the likely result. The government would be forced to tighten its belt further, exacerbating the problem. Vicious circle.
It will be a really tough call for the economically weaker countries (the PIIGS, or Garlic countries – no offence) to do well for themselves within a euro-zone that enforces fiscal austerity. There will be a temptation to escape that harness, possibly by reverting back to their own currency. Or maybe even a “garlic currency”. Whilst this would be a rocky ride for sure, it’s not as bad as an uncontrolled implosion. What matters is that the one and only sustainable step to take for the euro-zone to be resolved and for the euro to survive, is for them to move towards a fiscal union. And we have now embarked on that road, hallelujah. Onwards and upwards.
Whilst very early days, the major fundamental source of uncertainty has finally been addressed. Surely there will be more crises, but at least they will be focused in the right direction and as such move away from full out disaster scenario’s. That is an important ingredient for more confidence and less uncertainty
Financial markets are not yet convinced
Whilst most analysts will probably agree with the point we make above, they are more concerned about the short term risk of a bank crisis. In short: the risk of banks running out of money, because they are running out of collateral needed for the ECB to lend them emergency funds. If that happens the banks would probably need to be nationalized. Nationalized by a sovereign that doesn’t have money itself, leading to a worsening of the sovereign debt crisis. Again, a vicious circle.
What would be the solution, the circuit breaker? As BBC’s Robert Peston says: “It's the same as it ever was: mutualisation of all the eurozone's debts, which in practice means that the mighty German sovereign balance sheet would stand behind the enormous liabilities of the rest of the eurozone ….. but that won't happen unless and until there is an all-powerful finance minister (in effect) for the whole of the eurozone, to reassure Germany and the German people they wouldn't be throwing good money after bad.”
Perhaps there are other solutions as well (Peston is always gloomy), which quite likely will involve the ECB. But quite clearly, this is the biggest short term uncertainty that needs to be taken care of.
If our analysis is correct, this is what will happen. Economic uncertainty will slowly diminish and a sense that we’ve seen the worst will start to prevail. Once that happens, the first Buffett’s will enter the market, which no doubt will be the bigger, professional players in the market. That will stabilize prices and the most sought after wines and vintages will start to go up again. This in turn will encourage other players to step in, including new money that has not previously been employed in fine wine and is attracted by both the fundamentals and the prospect of the fine wine market professionalizing. But what is needed for this to happen is a nascent belief that the European banks will not fail.
When? Not long now… All eyes on Signore Draghi.
A few things. Remember what happened on the financial markets in the Spring of 2009. It doesn’t take a whole lot for an upsurge in demand to lift fine wine prices. Buffett’s quote “We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful”.
Wouldn’t it be nice if we can once again focus on wine, rather than finance?