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While the basic economics of supply and demand affect pricing of any good, for items marketed globally such as fine wine, significant shifts in currency values in major markets will take their toll.

"Cannot take it any longer" 

Yesterday, Reuters ran a story titled Burgundy wine prices hiked in U.S. due to weak dollar (read it, it's short).  Prices are being raised 10%-20% in the U.S. (the second biggest Burgundy market after Britain) as "they cannot take it any longer."

Burgundy demand is also high (see Burgundy exports to hit all-time high and my prior post, A leading indicator of higher Burgundy prices).  Therefore, if the U.S. market balks at higher prices, the wine will simply be sold elsewhere.

Just how much as the dollar weakened?

The dollar has depreciated 19.6% against the Euro since the beginning of 2007 and 26.5% since January 2004.  Given that the dollar fell 10.7% against the Euro in 2007, its decline in Q1 2008 has accelerated. 

The broader impact of the weak dollar on wine prices

• Domestic wine will become better values relative to imported wine (although certain items used in making some domestic wines such as French oak barrels have increased dramatically in price).
• Domestic U.S. retailers will increase their efforts to sell wine abroad.  See my post from earlier this week, Vinfolio to open Hong Kong operations.
  
• Foreign buying in the U.S. will increase (including European wines being sold back into Europe).
• Foreign investment in the U.S. wine industry should rise.

Bottom line: Fine wine prices are set globally and are on an upward trend given that rising demand is outpacing new supply (see Why fine wine prices will keep rising).  Fundamental shifts in currency values will cause supply to shift to other markets as well as new opportunities for those paying attention and able to operate globally.

P.S.    Today is the last day to vote for this blog in the 2008 American Wine Blog Awards.  Read about it and vote. 

The chart above shows auction prices (per 750ml bottle, inclusive of buyer's premium) of 1990 Petrus in individual lots sold at major auctions houses worldwide over the past five years according to the Wine Price File (see more details on Vinfolio's site).  The relative performance displayed here could be repeated for many other fine wines.  What's going on?  It's simple -- demand has steadily exceeded supply.

What about the future?  The long term trend for fine wine prices is fundamentally upwards because growth in demand is likely to continue to outpace supply. 

Here's my supporting rationale: 

1. Wine has become a luxury good.  Wealthy consumers are increasingly buying it for other reasons than drinking it, including as a sophisticated way of displaying their wealth.
2. Wealthy consumers are less price sensitive when it comes to maintaining their lifestyles and often chase the same status symbols, as pointed out by Robert Frank of the WSJ's Wealth Report in his post, "Inflation soars for the rich."  Check out Forbes' cool interactive chart of its Cost of Living Extremely Well Index.
3. Fine wine is a global market.  Just examine the countries of origin of the top ten bidders at most major wine auctions.  Buyers seek out their chosen wines wherever in the world they may be found.
4. Supply of the best known brands is relatively fixed.  Lafite-Rothschild is simply unable to plant additional acreage to accommodate increased demand.  In Bordeaux and Burgundy at least, this is the norm.
5. Wine import duties are more likely to fall than rise.  What would be the impact on fine wine demand from China's burgeoning multimillionaire class if China were to cut its 50% wine import duty dramatically?  See my earlier post on wine import duties.
6. Wine consumption trends are up.  Per capita wine consumption rose 17% in the U.S. from 2005 to 2006.  The potential for growth in other economies is huge.  E.g., China's per capita consumption rate is only 6%-7% of the U.S.'s.  Also see my post on the Top 10 reasons driving wine's growing popularity.
7. The trend towards wine investment helps fuels prices.  Rising wine prices have attracted interest in wine as an asset class from both individuals and professional investors.  For example, in the UK, several wine investment funds such as The Wine Investment Fund and The Vintage Wine Fund have emerged (both founded in 2003).  These funds acquire and hold large quantities of fine wine which in turn creates greater scarcity and supports higher prices.

Bottom line: Those of us who enjoy drinking fine wine need to get creative on financing our "habit" (perhaps by buying additional quantities to sell later for a profit) or by seeking world class wines from newer regions or wineries that have yet to be recognized as such.

Wine collectors often wonder whether, and how much, factors such as label condition, fill levels, cork condition, capsule condition, and color, impact the value of a bottle of wine.

The first level of triage one needs to perform is whether the contents of the bottle are likely to have been negatively impacted by whatever the "condition" is.  If there's a distinct prospect of the wine being bad, then the bottle is worthless in my view as buying it boils down to a pure gamble. 

Even when conditions have no impact on the wine itself (e.g., torn labels), value can easily be negatively affected.  A good test to apply is to ask yourself whether an average group of consumers for the particular wine in question would be less likely to buy that bottle because of its condition.  The higher the percentage that would decline, the larger the discount will be.  Precise value adjustments for different conditions are difficult to determine as this would require a multi-variable regression analysis of what are often very subjective assessments. 

A practical approach to evaluating varying bottle conditions

Vinfolio operates on the premise that buyer satisfaction is paramount so we inspect every bottle we purchase according to a published set of Inspection Guidelines.  These guidelines effectively determine what we define as commercially acceptable criteria for selling wine at a uniform price point.  Any bottle which does not meet our condition criteria is rejected (i.e. not purchased).  In the event a customer is not satisfied with a bottle's condition, we'll simply take the wine back (which is very rare).

Reminder on preserving the value of your wine

By far the most important step you can take to preserve the value of your wine is proper, climate-controlled wine storage (which many of our criteria are intended to measure).  You should still do your best to avoid creating cosmetic damage to labels and capsules when handling your wine, even if you plan on drinking all of it, to keep your options open for selling it later at maximum value.

Note: This post was stimulated by an item on the eRobertparker.com Squires board titled "Effect on value for label damage?".

P.S.    The photo shown is an example of a bottle of Peter Michael chardonnay that we declined to purchase because of its torn label.

A couple of news stories in the past month focused my attention on the potential impact of unleashing pent-up global demand for fine wine that is now impeded by high import taxes.  Specifically, Hong Kong decided to cut its wine import duties in half and South Korea concluded free trade agreement negotiations with the U.S. which look likely to result in a complete elimination of its high wine import duties (see Korea Trade Agreement Moves Forward: Wine Industry to be a Major Beneficiary).  As pricing is about supply and demand, sudden reductions in taxes could cause demand to rise in a world of relatively fixed supply of fine wine.  

See the chart below for a quick overview of major Asian countries' wine import duties in comparison to the U.S.  The basis of import duties and taxes varies by country, ranging from the value of the wine to volume and alcohol levels.  The data below is based on a single case of wine valued at $1,200.  While Hong Kong's and South Korea's dramatic future tariff reductions are impressive, their economies are relatively modest.  The bubble size in the chart represents the relative GDP among the countries shown, and therefore the potential purchasing power which could be released to impact wine prices.  The two countries combined represent less than 5% of the U.S.'s GDP so the planned wine import cuts are not going to redefine price levels on their own. 

"What if" scenarios for China and Japan

1. China - What's more interesting perhaps is China's high duty combined with its purchasing power (about 60% of U.S. GDP and growing faster).  What if China were to cut its 49% duty to zero?  Given the growing number of millionaires in China (now in the 300,000-400,000 range), you can bet a such a change would impact fine wine prices (see my other recent post, China's long-term impact on fine wine prices, and Selling wine to the affluent Chinese).
2. Japan - Japan's fine wine market is already very strong and while a reduction of 15% is much less than 49%, one can imagine a more immediate impact given the far more established channels of selling fine wine into Japan.

Bottom line: The stage seems set for long term price rises for fine wine.  Wine collectors need to keep in mind that the world of fine wine is a very global business in which trends or market discontinuities elsewhere will impact their wallets and/or investment approaches.

Today's Wall Street Journal (WSJ) had a front page story on wine counterfeiting titled "U.S. investigates counterfeiting of rare wines" (WSJ online subscription required).  When I arrived at the office today, I had a voice mail from Robert Frank, the writer of The Wealth Report blog at the WSJ (which is billed as covering "the lives and culture of the wealthy").  He wanted to discuss how wine buyers could avoid fakes.  My comments are incorporated into his blog post today titled "Oenophiles see double."

In the discussion with Robert, I noted that buying wine sourced directly from the chateau (which is called "ex-chateau") or from individuals who bought it upon release is the ideal defense against fakes, as the "chain of provenance" is fully known (including storage conditions). 

Quantifying the value of buying ex-chateau 

I realized when making this point that I potentially had a method for quantifying the market pricing premium for authenticity. The other day when reviewing the price list of a very reputable British wine wholesaler (Farr Vintners) specializing in Bordeaux, I noticed that they listed certain Bordeaux wines with a notation that the wine was "ex-chateau."  If they happened to also offer the same wine, vintage, and bottle size without the ex-chateau designation (and in otherwise excellent condition), then an analysis of the price differences might reveal at least this firm's educated view of the price premium for authenticity (as storage conditions of non ex-chateau wine from Farr is typically impeccable).

The outcome 

In examining Farr's full Bordeaux price list, there were 18 examples that met the criteria which spanned the 1986-1998 vintage time frame including wines from Latour, Mouton-Rothschild, Haut Brion, and Pichon Lalande as well as less expensive Bordeaux such as Lafon Rochet.  The chart below displays the results with a trend line based on a linear regression approach.  A few observations:

1. The trend is for an increased premium for older wines which makes sense as the risk of fakes intuitively is greater the older the wine.
2. Only 1 of the 18 examples had no price premium (and this was for the cheapest wine).
3. Absolute price levels were less correlated with price premiums than vintage in this limited data set.  E.g., the five most expensive wines (priced at $2,000 to $5,000 a case), had 3 examples in the 9-10% premium range but also one at 5.6% and one at 2.8%.
4. The overall median premium in this sample was 5.7%.

One way of interpreting the authenticity premium is as a measure of the potential liability that an auction house or other seller of fine wine exposes itself when selling such wine.  If one extrapolated the trend line to 1947 (as an example of a great wine year), the premium (or potential liability of selling non ex-chateau wine) rises to 32.2%.  That's about the total gross margin percentage between buyer's premiums and seller's commissions that a major auction house would earn when selling a wine of that vintage.

Bottom line: Pay attention to provenance and be prepared to pay more for when it's solid -- it's worth it.

In part 1, I explained certain difficulties with valuing fine wine and the importance of distinguishing between transaction prices (from auctions) and asking prices (from retailers). When Vinfolio released its enhanced valuation component of our free VinCellar online cellar management software in early January, we concluded there were two fundamental types of wine values which collectors sought to determine:

1. Replacement value – This is what you’d use to establish the insurance value of your collection. Retail prices are the basis of valuation because they represent the most likely price you'd have to pay to replace a bottle.
2. Sales value – If you plan to sell part or all of your collection, this estimated value (excludes any third-party fees) uses auction prices as the basis of valuation because they represent actual transaction values (inclusive of buyer's premiums paid).

Valuation “certainty”

Our algorithms to estimate value use as much data as is available. However, there’s often a wide range in the component data between high and low prices (whether at auction or in the retail channel). For example, Winesearcher’s site describes the average spread between the high and low prices for a wine as 2x the low price. Any valuation estimate, therefore, is just that – an estimate.

Vinfolio’s data sources and methodology used in VinCellar

Retail data

Vinfolio uses retail price data licensed from Winesearcher, the leading wine price search engine with worldwide data drawn from over 8,000 wine stores and retail outlets. After performing various steps to map retail listings to specific wines and cleanse the data to ensure validity, Vinfolio calculates the average U.S. retail price for the prior 12 months as its retail price estimate.

Auction data

Vinfolio uses auction price data from our own Wine Price File, the leading source of wine price auction results. As auction prices fluctuate from auction to auction and since there may be limited auctions for any given wine, Vinfolio developed a proprietary algorithm to determine an estimated auction value. The algorithm is based on the following principles:

1. Recent results are more representative of current values than older results and are therefore weighted more heavily.
2. To ensure a representative value, we use a minimum number of auction results when available -- this may sometimes require using older results.
3. In the event that our minimum number of results is unavailable, we may base our estimated value on as few as one auction or auction results up to eight years old.

“Plus” scenarios

The image above is a snapshot of a VinCellar valuation screen for a private cellar. You’ll note that there are two additional scenarios, Retail Prices Plus and Auction Values Plus. Not all wine has a current retail price or is sold at auction, so we provide a way to increase the number of wines with estimated values in either the retail-only or auction-only scenarios. These two additional scenarios are determined as follows:

1. Retail prices plus – When there’s no retail price but there’s an auction value for a wine, we’ll estimate a retail price by using 125% of the auction value. This is consistent with an average higher price level achieved at retail for the more convenient method of buying.
2. Auction values plus - When there’s no auction value but there’s a retail price average for a wine, we will estimate an auction value by using 80% of the average retail price. This is the reciprocal of the rationale in the “Retail prices plus” scenario.

A word on the impact of wine condition and provenance

Bottle condition and a wine’s provenance have a direct impact on value. The approach used above inherently assumes that the wine being valued is in a condition worthy of being sold at auction or a retailer. When editing data for the Wine Price File, we'll actually exclude prices from the database if we feel the condition of an auction lot's wine was below the normal standard. If you know that wine you’re valuing has superior provenance versus the norm for that wine, then you could justify assigning higher values.

Bottom line: Valuing fine wine is more involved than simply looking up a market price for a financial security. But it’s possible to tackle the task systematically as outlined in this two-part post. If you’re interested in maintaining up-to-date values of your wine, use our free VinCellar online cellar management software by registering for a free Vinfolio account.

Nature of the wine valuation problem

Establishing the current value of your wine collection is more difficult than valuing a public securities portfolio. Even relatively illiquid securities have a quoted bid-ask price which can be used as an “arms-length” fair market value. Valuing wine is more complicated because:

1. Every combination of a wine name, vintage, and bottle size represents a unique item to be valued (even if one ignores condition issues) which generates an enormous number of items.
2. The produced quantity of any item is often quite small, which limits the potential transactions which can be measured to benchmark a value.
   
3. Transaction data is not centralized in one place. The best sources are wine search engines like Winesearcher.com for retail asking prices and Vinfolio’s Wine Price File for major auction house transaction data.

The difference between transaction prices and asking prices

Normally, the basis for establishing fair market value for any item uses transaction data as this means that the buyer and seller ultimately agreed on a price. Retail prices shown on Winesearcher.com are asking prices and are usually higher than completed transaction values from auctions.

A retail asking price is not a confirmation that a wine is selling. Moreover, some retailers routinely start with a high price and then gradually reduce the price over time if a wine does not sell. Therefore, at any given time, one has no idea whether the retail prices quoted on Winesearcher actually represent prices at which a wine is being successfully sold (which is the true test of fair market value).

How does one reconcile these differences given that all wine is not sold at auction and retail data is more abundant? In part 2 of this topic, I’ll address how Vinfolio has tackled this issue in our free VinCellar online cellar management software.

A recent article in the Economist titled “Fruity little numbers” and a post in the Dollars and Sense blog titled “The price of wine – not about the wine” inspired me to go back to Economics 101 and apply the law of supply and demand to explain fine wine pricing.

Supply

For any given vintage of a wine, the maximum supply is determined by total production in that year. Limited production relative to demand (e.g., Screaming Eagle, Harlan Estate, Le Pin, Petrus, DRC) leads to high initial prices. As production is fixed and supply can only decrease with consumption or with collectors storing wine for later consumption, the supply curve will only ever shift upward and to the left. Therefore, for any given quantity demanded, the price should increase with less available supply (unless demand falls faster – perhaps by negative changes in elements contributing to demand such as a reduced score from a major wine critic).

Demand

Demand is driven primarily by factors shaping consumers’ perception of quality:

1. Scores and reviews from professionals and the wine community. Parker 100 wines, Wine Spectator's Top 100 wine list, public community tasting notes, etc.
2. Appellation of origin. Terroir matters.
3. Reputation of the producer, of proven “celebrity” winemakers, and of the wine’s ability to age. Newer garagiste producers need to develop track records.
4. Marketing efforts by producers including label design, bottle selection, promotions, events, advertising, and extent of domestic and international brand development.

Other factors include:

1. The growing global population of wine drinkers, not only in the U.S. but in new markets like Russia, China, and other parts of Asia.
2. Investment appreciation potential, which is not necessarily a primary factor but may be a secondary consideration to many when deciding to buy fine wine.

For older wine, the provenance and bottle condition directly affect demand including:

• Past storage conditions and history
• Original wooden case or packaging intact
• Bottle fill levels
• Label, cork, and capsule condition
• Color

What about the costs of production?

Fine wine is generally not priced on a cost-plus basis once one a certain price threshold is exceeded (e.g., $50?). The producer’s objective is to price to perceived value, not costs. So get over the fact that Screaming Eagle now sells for $500 from the winery while their costs are a fraction of that. When demand is high relative to supply, production costs are irrelevant.

The impact of high prices on wine buyers

• If you are “priced out” of a wine you like, move on to discover alternatives in your price range. They exist.
• Get recommendations and advice from your retailer or others.
• Trust your palate to assess quality instead of relying on perceptions of quality that others are trying to shape for you.

Chart source: Wikipedia