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Tuesday, June 28, 2022

Illiquid Liquid Assets

 

S.W. and Rich Hermansen
Guest Writers
wine@lbknews.com

No question about increases in prices of premier wines during the last few years. We remember fondly a Joseph Phelps Insignia blend of Bordeaux grapes from Napa Valley California. We paid $199 for a bottle at a restaurant. The retail price of the same Insignia vintage would likely be $125. The 2007 vintage now sells for $400 per bottle. If, for example, a $125 per bottle wine appreciates in price to $400, the gain in value likely exceeds the gain of a stock in the market. (Recall the Great Recession in 2007/2008.)

Vendors of wine futures of course recommend buying vintages of a wine before a vineyard bottles and ships them to wine stores. Similar to commodity futures trading on the Chicago Mercantile Exchange, but much longer term, buying a wine future offers the prospect of increases in the price of, say, a case of twelve bottles from a vintage of Chateau Latour Bordeaux. Buying wine futures could in theory serve as a hedge against inflation of wine prices. Disclaimer: we are not recommending doing that. A promising vintage (growth) may turn out a few years later to be a dud. A downturn in the economy could weaken the demand for luxury goods such as fine wine. The risk of poorer than expected price gains, perhaps even losses, has to temper our hopes for gains. A basic question investors in the stock market have to ask also arises in wine futures: if buying and holding wine cannot fail to profit investors in futures, why would sellers of futures not go to banks and borrow money to realize these sure gains? Could it be that bankers who evaluate loans to speculators rate wine futures as much more risky than sellers suggest?

We must also factor in the chance that a given case of wine has to be kept in ideal conditions to maximize future price increases. A surprisingly high percentage of wine bottles fall by the wayside: even well wrapped corks or screw caps can develop leaks and let bacteria inside the bottle, ‘corking’ (contaminating the wine). Extremes of heat can oxidize a wine and diminish its quality, to say the least. Unlike more liquid assets such as cash, bank accounts, bonds, or common stock, sellers of bottles of vintage wines have to connect to buyers, negotiate prices, and pack and ship bottles. Although buyers have web sites that support the transactions, cashing in a wine portfolio takes time and expense. Investors consider vintage wines a valuable but illiquid asset.

Evaluating vintage wines as an investment opportunity entails many complex choices: the growth or vintage, specific vineyards and winemakers, interest rates, changes in inflation rates, currency exchange rates, storage costs, predictions of gains, risk, and how long to hold them. To our good fortune, Walter Labys, Benedum Distinguished Scholar and Professor Emeritus of Resource Economics in the College of Agriculture, Forestry and Consumer Sciences at West Virginia University, Master Knight by the Order of the Vine in Sacramento, and holder of a Wine Diploma in Tasting from the Agricultural Extension Division of the University of California in Berkeley, amidst other honors too numerous to mention, happened upon our Wine Times column while on vacation. He has offered to share his insights and publications (for example, Wine as a medium term investment vehicle, with Bruce Cohen, in the Eur. R. agr. Eco. 5(1) 35-49 1978). This technical paper presents an evaluation of gains and risks using data on wine vintages and sales during a prior episode of increasing inflation rates (1967-1974). In 1978 Walter wrote “It would take a considerable leap of imagination of a financial analyst to recommend wines to his client based on [our data analyses]. The conclusion must be that one should buy wines for the purpose of drinking them. These assets may be liquid, but the liquid is better drunk”.

Wise words. With Walter’s help, we plan to explore more recent data on wine futures gains and risks in future Wine Times columns.

S. W. Hermansen has used his expertise in econometrics, data science and epidemiology to help develop research databases for the Pentagon, the National Institutes of Health, the Department of Agriculture, and Health Resources and Services. He has visited premier vineyards and taste wines from major appellations in California, Oregon, New York State, and internationally from Tuscany and the Piedmont in Italy, the Ribera del Duero in Spain, the Barossa Valley and McLaren Vale in Australia, and the Otego Valley in New Zealand. Currently he splits time between residences in Chevy Chase, Maryland and St. Armand’s Circle in Florida.

Rich Hermansen selected has first wine list for a restaurant shortly after graduating from college with a degree in Mathematics. He has extensive service and management experience in the food and wine industry. Family and friends rate him as their favorite chef, bartender, and wine steward. He lives in Severna Park, Maryland.

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