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Perception, Reality & the Last Laugh

Two teams of hikers, each crossing a glacier, approached a crevasse. One team saw the crevasse in time and stopped. The other team did not see the deep hole in the ice until the leader had fallen into it, at which time it became rather dramatically perceptible. Different perceptions obviously result in different actions. Perception, in this instance, changed action but perception did not change reality: the crevasse was really there whether noticed or not. Human systems, however, can be more complicated because perception can actually change the reality, at least to some degree.

Consider a thought experiment in the bulk wine market. Imagine 100 sellers of bulk wine and 100 buyers. The amount the sellers want to sell happens to be exactly the amount the buyers need. In the first scenario, however, all of the players think (falsely) that the market is short of supply. Because of this perception, buyers are eager to purchase as soon as possible and they snap up any wines offered, often paying full asking price in order to secure the purchase. Sellers take this as absolute proof that the market is short and they are convinced that prices will increase over time. Most of them wait to put up wines for sale. Buyers get increasingly anxious as few wines are listed and they bid up prices, confirming the sellers’ perception of a short market and rising prices. By the time most sellers list their wines, buyers are ready to pounce on whatever they can get their hands on in order to finish blends prior to harvest.
In the second scenario, the market is again perfectly balanced but this time buyers and sellers perceive the market as long. Sellers are worried that they might not be able to sell their wine and so they rush to get the wines listed as soon as possible after harvest. Many wines come on the market but buyers figure that the longer they wait, the lower the prices and the better the selection. Few wines sell and sellers drop their asking prices. A few buyers cherry pick the best lots and three or four make low-ball offers. Most buyers wait and sellers get increasingly desperate. By the time buyers are ready to make their move, the sellers will take just about any offer, especially if they need to empty tanks prior to harvest.

The same amount of wine changes hands in both of these scenarios. Exactly the same balance between supply and demand was made to act like a short market or a long market, depending entirely on perception. But perception can do even more than that. Perception can for a while make a short market behave like a long market and visa versa. In this case, however, reality gets the last laugh. If most players think there is a shortage of supply even when there is really a developing excess, buyers will rush to buy and sellers will be slow to sell and the market will act like a short market, confirming the initial perception. This can only last for awhile, however. Before long, more sellers will emerge and buyers will fulfill their needs and step out of the market. Sooner or later, the excess of supply will become evident and perception will come into line with reality, often with a violent correction. The same short-term mix-up and eventual correction will happen with a short market that is perceived by the overwhelming majority to be long. Sellers will be anxious to sell, buyers will delay buying and the distressing symptoms of a long market will appear. Eventually, heel-dragging buyers will make their move, only to discover that many other buyers are making the same move at the same time and they all want the same lots of wine.

How does this apply to the current market? Unfortunately, there is no way to get an absolutely objective view of the total balance of supply and demand (although our publication, The Turrentine Outlook, does provide the most comprehensive overview). The market is certainly behaving like there is a significant excess. Grape sales in general are very slow even as summer begins and crush draws near. The bulk market is also slow for most varieties. Sellers are very anxious to sell. A few buyers are cherry-picking the best quality lots but most buyers are pretty quiet. What no one knows for sure, however, is what volumes and price-points of wine our old friends, Connie & Conrad Consumer, are going to want. More than any other factor, the ultimate direction of the market during the next year will be determined by this unknown consumer demand. If past patterns prevail, at some point, Connie and Conrad may feel that the worst of the recession is over and that they can splurge at least on little things, like good wine. This may not happen for six months or twelve months or eighteen months or twenty-four months. When it does happen, however, it will catch the wine business short. Consider the following factors:

1. Banks are still under pressure to enforce lending standards and credit remains tight. This forces everyone from restaurateurs and retailers to wholesalers and wineries to keep inventories unusually thin. This often leaves growers stuck with inventory because there is no one else upon whom they can push it back. An improvement in consumer sales would help ease the credit-crunch and cause the supply chain to replenish.

2. We are not likely to see the same big imports of Australian Chardonnay this year as there was last year. The 2010 Chardonnay crop was down in Australia and the Aussie dollar is stronger against the U.S. dollar than it was at the time of the big influx, increasing the cost of importing Australian wine. Supplies of the main varietals from other global producers most competitive with California are not way out of balance.

3. Rain, wind and cloudy weather in California during bloom for many earlier varieties in many regions may have reduced the expectations for a big 2010 crop and could also affect bud fruitfulness for 2011.

4. There are ample quantities of 2009 reds on the bulk market. In tough markets, however, sellers do not always invest in oak and other finishing that costs real, out-of-pocket dollars. When winemakers finally get the green light from finance to purchase 2009 red wines, they may not have time to finish the wines before bottling. In the midst of an excess of supply, there could be a shortage of red wine that is actually usable as just-in-time inventory.

The grape and bulk wine markets are likely to be tough until consumer sales have established a clear trend towards both increasing consumption and increasing price-points. And nobody knows for sure when that will happen. In times like these, growers and wineries need to remain flexible, doing what is necessary for short-term survival but also keeping an eye on future opportunities. You could compare the challenges to a hike across a glacier. For safety in perilous conditions, it helps to consult with a guide who has explored much of the glacier and knows where the crevasses are and how to find the best passages around them. Give us a call to identify the opportunities for your unique situation over the next few months, and years, in a constantly changing supply and demand equation.

Bill Turrentine