China's Taste For Wine

Though not traded on a futures exchange, wine is still, literally anyway, a commodity.  Further, it's a commodity that many people invest in, typically in the form of collectible rare/old wine.  At a party when this ever comes up, usually someone says something like: "over time, rare wine is one of the safest investments when compared to blah blah blah".  There's rarely any data to back this up, but that doesn't matter because it seems believable and it's kind of cool.  Someone should look into that.

But rare wine isn't the order of the day.  No, today I'm interested in exported wine.  Specifically, wine exported to China.  A recent article on GlobalPost.com (which is a publication I had never heard of until two weeks ago) addresses growing wine consumption in China:

Wine bars and boutiques are sprouting across Beijing, and trendy young consumers are flocking to wine-tastings at swish hotels. A dramatic 54 percent rise in wine consumption in China between 2011 and 2015 is predicted, a reflection of the increasing affluence of China’s middle classes, according to a new study by Vinexpo, Asia’s biggest wine exposition.

Let's leave aside for the moment that this study was conducted by a "wine exposition" (whatever that is) and focus on the purported reasoning behind the growth.  Specifically, that the increase in wine consumption is "a reflection of the increasing affluence of China's middle classes."  The article also goes on to say that 40% of Chinese wine imports are from France, specifically.  Plenty of countries make wine; that the increase in imported varietals seems to be focused on French wine implies not just that an increasingly affluent middle class wants to buy wine, rather, that they want to buy good wine.

Curious about how this trend might affect the American wine market, I pulled some numbers from the USDA Website via the FAS USTrade Query system.  First, a look at total wine exports from the US, by country, over the last ten years (note, all volumes reported in Kiloliters):

US Total Wine Exports by Country, 2002 - 2011 (click to enlarge)

The first takeaway?  Whatever amount of American wine the Chinese are importing now or in the next few years is largely insignificant at this point.  We ship so much wine elsewhere that any changes in Chinese demand for US wine are unlikely to be of major concern for the next few years.  That doesn't make it uninteresting, however.  To get a better idea of the changes in China, specifically, let's take a look at the percentage of total US wine exported to four specific countries over that same time frame:

Percent total wine exports to four countries (click to enlarge)

Okay, now we're getting somewhere.  As a percentage of total wines exported, one can see that the amount of wine we ship to China and Hong Kong has been gradually increasing, while that same total for Japan and France hasn't been following any overt pattern.  Now let's compare the raw totals for the three biggest Asian importers of US wine:

Total imports from Japan, China, and Hong Kong (click to enlarge)

Interesting.  The total amount of wine exported to Japan has more or less been hovering around 25,000 kiloliters, while exports to China and Hong Kong have steadily grown.  But remember, the article tells us that the Chinese are developing a taste for French wine, which, accurate or not, has a reputation for being better than most other countries' wines.  The next question, then, is what type of wine is China importing from the US?  When reporting wine export numbers, the USDA breaks out the figures into six categories:

1. Sparkling Wine
2. Effervescent Wine
3. Grape wine of an alcoholic strength not over 14% in containers holding 2L or less.
4. Grape wine of an alcoholic strength not over 14% in containers holding more than 2L.
5. Grape wine of an alcoholic strength of over 14% in containers holding 2L or less.
6. Grape wine of an alcoholic strength of over 14% in containers holding more than 2L.

I don't know, exactly, what the distinction between sparkling wine and effervescent wine is, but types 3 through 6 could generally be thought of as "standard bottled table wine", "standard boxed table wine", "fortified wine" and "holy hell I have a death wish", respectively.

Standard table wine makes up the bulk of exports to all three of these countries, but here's where things get interesting.  Let's look at how export numbers to Japan, China, and Hong Kong compare when caged specifically to standard table wine:

Standard table wine exports to Asia (click to enlarge)

Interestingly, the China and Hong Kong trends for standard bottled table wine follow pretty closely the general trends for ALL wines exported to those countries, while the Japanese trend looks altogether different.  A little stats shows that this is precisely the case.  Who knew the Japanese had such a taste for Night Train? 

• R_squared value comparing total global wine exports to standard table wine exports by country:
• Japan: .1567
• Hong Kong: .9754
• China: .9671

That means that ~97% of Hong Kong and China's change in wine importation from the US over the last ten years can be explained in terms of their importation of wine at 14% alcohol in containers smaller than 2L.  That is, standard table wine. 

The article mentions that the majority of wine consumed in China is produced domestically.  What the change in export number then means, really, is not that China is drinking more wine, per se, but that more people are drinking better wine.   To that end, the article's thesis is entirely correct, but not just for French wine, for all high quality wine.  Until Chinese vineyards begin rivaling the quality and consistency of the best vineyards in France, the United States, and elsewhere, as China's citizenry gains spending power in the global economy, look for this trend to continue.

If you were hoping to come away with an investment idea here, you may be out of luck; there is no grape futures contract in existence, but even if there were, it's unlikely investing in such an instrument would be worthwhile.  Grapes aren't the key here, it's craftsmanship, tradition, and quality.  To that end, investors in rare wine may actually see a boon from the growth of wine exports to China.  If demand for quality keeps up, that rising tide should, in theory anyway, boost the values of all high quality bottles.


Normally I'd say something like "it's a good time to own a vineyard in Napa or Bordeaux", but really there's no need to state a priori truths.

Even Newer Futures Contracts!

Hard Assets Investor just published an article of mine running down the new futures contracts that I had discussed previously (Cobalt, Molybdenum, and Distillers' Dried Grain), as well as the proposed Canadian Oil Futures contract. You can read the full article here.

Nice try US government, we're still not buying natural gas

Two weeks ago the Wall Street Journal ran an article with the headline: "Natural-Gas Data Overstated". Apparently, the Energy Department has for some while been screwing up its statistical projection for natural gas and significantly overestimating the country's gas supplies.

Basic economics tells us that when demand stays constant and supply diminishes, prices go up. And according to this report, supplies, in fact, have diminished, albeit somewhat artificially. And how did the market react? It didn't:

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View the full FUTURE:NG00 chart at Wikinvest

Other than that spike the day of the announcement (April 5) natural gas investors apparently couldn't care less about the US Government's overstated inventory figures.

This highlights the fact that in the US we have access to about as much natural gas as we could ever want. Granted, a lot of it is underground, but unless gas stocks were actually low (like, in danger of running out) knowing that our stocks are slightly less than previously thought doesn't actually affect the price. At some point, the functional supply of gas changes from a number of mmBTUs to the categorical figure "plenty". If we got to a point where we were consuming enough natural gas to see stocks diminishing the gas drillers could ramp up production so quickly that no blip would be seen.

So, nice try government, but the market knows better.

Building a Better Gold/Silver Spread

Yes, I realize the blog has been morphing into my simply posting links to articles I am writing for other blogs, but I assure you there's still original content to be had here.

Regardless, here's a new article I wrote for Hard Assets Investor, wherin I devise a multivariate statistical model for the Gold/Silver spread.

The basic idea is that, since gold and the US Dollar are highly correlated, and gold and silver are highly correlated, while silver and the dollar are NOT highly correlated, you can use silver coupled with the USD exchange rate in a multivariate model to observe statistical deviations from historical norms.

The takeaway? Even though past performance does not guarantee of future returns, according to this model at least, gold is trading well above its historical expectation for the current values of silver and the dollar. If you buy into the model, the play would be to short gold, buy silver, and buy a foreign currency with US Dollars.

Diversify by investing in grains

On Monday, Hard Assets Investor published another article of mine, the premise of this one is that it turns out Grains (Corn, Oats, Rice, Soybeans, Wheat) have fundamentally NO correlation with the broader stock market. This makes them an excellent candidate for investors seeking true diversification.

When I say "true" diversification, what I mean is that most investors' idea of diversification is owning lots of different types of stock, and maybe a few bonds. The problem is that stocks (and even bonds, depending on which ones you own) tend to have high co-correlations. That is, if the share price of Coca-Cola suddenly bottoms out, you can bet that a lot of other companies will as well. If interest rates go up at some point ever in the future (I know, ridiculous right?), all other factors being equal, the entire stock market will go down. Lot of good your owning stocks in different industries does you then.

The traditional view has long been that you should own some combination of stocks, bonds, and cash or money-market funds, weighted depending upon your risk tolerance and age. The problem is that with those three categories its nearly impossible to diversify within your risk tolerance. That is, stocks are riskier than bonds are riskier than cash.

That said, commodities provide just as much risk (and upside) as stocks while, as my research demonstrates, offering little to no correlation with the broader market, depending upon which commodities you invest in (i.e. not oil or gold).

You all know my issues with Commodities ETFs, but if you're purely looking for diversification, an ETF that holds a big basket of different grains might be the way to go. Personally though, if you have an account with a futures brokerage I always prefer owning the contracts directly.

The Problem with Commodities ETFs

Last week, Hard Assets Investor published another one of my articles. In it, I compared the correlations between several energy ETFs and the prices of commodities they are tracking. The takeaway message is that, for the most part, ETFs do a bad job tracking commodities prices. There are a few reasons for this.

The first, and primary reason why the correlation is less than perfect, is that the front-month futures contract for every commodity is constantly changing. Since most ETFs hold only the front-month contract, this means that sometime before expiration, the fund must sell its holding of one (soon to expire) contract and then purchase another (soon to be front-month) contract. There is almost always a significant discrepency between the two prices, particularly if it's a commodity that doesn't deliver every month. Take a look at the futures chains on the CME group website for crude oil, gold, and corn. As of writing, the difference between the front month and second month contract is about 40¢, $1, and 10¢, respectively. That may not seem like much, but that price difference represents a pure loss in the value of the fund with every roll that takes place. Just to prevent declines, the fund would, on average, have to be increasing in value between 1 and 5% a month. That means that, depending on the commodity and the fund, a monthly percentage increase, if not sufficiently high, may actually mean you're losing money.

The second problem with ETFs is that they create a secondary market on top of what is already a volatile market in its own right. And, while the underlying instruments are the same for both, (futures contracts) the factors driving the supply and demand may be drastically different. For example, while natural gas might be moving up on strong demand resulting from a particular weather forecast, if the primary participants are energy hedgers, no such demand would exist for UNG, the world's biggest natural gas etf. As such, UNG might theoretically follow the price of gas with something of a lag, rather than actually track the price in real time.

Don't take my word for it, take a look at this graph comparing oil price movements with the price of USO, the world's biggest crude oil ETF, over the last four years:

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View the full Crude vs USO chart at Wikinvest

Now, you might be saying "those charts seem to follow each other reasonably well" but that's the problem. Reasonably well isn't good enough. An investor buying a share or shares in a commodity ETF that puportedly tracks the price of a commodity wants her investment to actually do just that, not merely track the price "reasonably well".

It's true that there are some ETFs, especially those dealing with precious metals, that eliminate the problem of the roll yield altogether simply by buying and hoarding the commodity in question and storing it in a vault somewhere; no futures contracts required. While certainly effective in mitigating the problem, this only works for a very specific subset of commodities that do not have a cliff for their usefulness. Other than those few cases, in general, the moral is that if you really, truly want exposure to commodities, don't waste your time with an ETF. As they stand, very few of them can be relied upon to achieve their goals. Though that may change in the future, for now, your best bet is get into the futures market directly.

New Futures Contracts!

Last week, a couple of the major commodities exchanges announced the addition of some new futures contracts to help producers and consumers of raw goods hedge their expenses, and simultaneously give commodities traders three more reasons to develop stress-related ulcers.

First, across the pond, the world's foremost metals market, the London Metal Exchange (LME) yesterday opened trading of cobalt and molybdenum futures. In shocking concordance with my previous post about the emerging need for a lithium futures contract, the cobalt contract is designed specifically with battery manufacturers in mind, cobalt being a major input to rechargeable batteries in things like laptops and cellphones. Molybdenum, which I had never heard of before this Wall Street Journal article, is apparently used in the production of stainless steel.

Meanwhile, here in the States, the ever-growing Chicago Mercantile Exchange announced that it will be adding a contract for distiller's dried grain (DDG), a by-product of corn ethanol production. This is interesting because, with the addition of the contract, which will begin trading in April, ethanol producers can now effectively hedge every step of their production. For example, before the harvest you might buy a corn contract so as to protect yourself from unexpected price swings at your local grain elevator. Then, once you've got your corn and begin distilling ethanol, you can sell both a DDG and ethanol contract to lock in prices for your two resultant byproducts. Further, you can buy or sell oil, gas, or natural gas contracts to take advantage of spread deviations between the fuels. This is also interesting because the DDG contract may become a major hedge-staple for corporations that produce ethanol for non-fuel purposes... you know, like Jack Daniel's. The government, and now the private markets, are conspiring to make ethanol a real and viable energy source with plenty of economic safegaurds.

A bizarre reaction to these announcements is concern that opening these contracts to the public will increase volatility in the prices of the commodities and could potentially drive them too far one way or the other. Yes, that is true, prices will become more volatile... but only for the traders. The hedgers (people producing and consuming ethanol) actually need volatility to protect themselves from things like price-fixing and sudden, unexpected swings. Without and open public market, there's no way to plan for and predict what DDG would and will cost. Also, hedgers are not entering and exiting positions over and over to make a quick buck, they are locking prices in, exiting positions, and taking the difference as market protection.