Restructuring Fangcun Tea Market

Restructuring Fangcun Tea Market<br>The Market Find Its Own Path

The end of 2011 was a winter of gradually fading enthusiasm. Index products of many speculators progressively underwent rational price reductions. After Zisha pottery auctions failed to meet expectations, the market also lost much of its fervor. The reason was actually quite simple. Although the market's investment channels are very limited, speculation is simply a basic part of the economic cycle. We mustn't forget that a decline in prices is another basic stage in the cycle following excessive inflation. These events reflect a fact in today's tea market. That is, funds flowing into the market are not as abundant as they used to be; or, in other words, investors have taken their profits and left the market. Essentially after weighing the risk and rewards, investors have chosen to step back. This explains the slump in prices of major label products over the past six months.

As the Puerh market has grown more mature, capital has become increasingly centralized. This has resulted in a situation in which a small number of producers of name brand tea dominate the market, which is evidenced by today's situation in which only Dayi enjoys relative strength. These circumstances have already given rise to a structural transformation. Dayi products appear on die market one-after-another. From this year's 7542105 to the most recent Dayi Zhi Lian, the market has repeatedly come to learn that, even though it loves Dayi tea, the price will not necessarily rise. This is similar to how a lover of Zisha pottery may favor the works of a certain famous artisan.The price may not be within reach, however. Even though you like his pieces, you may not be able to afford them.

No tea last year was pursued with more fervor than Dayi Zhi Lian. At the year-end Canton Fair, it received widespread acclaim and orders were off the charts. This infatuation was apparently unrequited, however. Buyers ordered future shipments rather than existing products, and prices fell by nearly 30% as soon as the Canton Fair ended. This was a new phenomenon that symbolizes new market realities. Prior to 2011, no products were more traded than the classic Dayi scries, of which 7542 is most representative. I believe this is common knowledge. This tea has served as the principle index of market strength for many years and also serves as the basis for selling and list prices of many other factory teas. Many of Fangcun tea market's major tea speculators use 7542 as an index. Falling 7542 105 prices deflated the market's inertia and revealed its true state. Even a tea marked as large as Fangcun and as powerful as Guangdong cannot withstand endless injection of new capital that seeks to replace the old with the new, especially when so many different products are available, and the production quantity of each type of tea is so much greater than in the past. Based on conventional wisdom, the market should not favor purchase of new Puerh over old Puerh; however, today trade of new tea is more active than that of old Puerh. This has led to many cases in which the price of old tea is lower than that of new tea, e.g., this year's Bada Mountain teas.

The price inversion of Bada teas this year reflects the general fact that the market's investment capital cannot move quickly enough. This phenomenon results when funds move in only a certain way and leads certain prices to rise while others fall, creating repeated, cycles of boom and bust. Several years ago Dayi products also experienced this simultaneous rising and falling of prices. Today product selection requires luck. Dayi tea is not a sure-fire way to make money; it can also cause you to lose money. Golden Dayi was considered good tea and was widely purchased, but those who placed orders for future shipment lost big, while Dayi franchise stores earned substantial profits. Likewise, 7542 105 was similar. Fangcun is a place of wonder due to its ability to evolve. Just like in the stock market, futures trading is becoming more and more common.

Although Fangcun now receives shipments at third-level prices and these prices are very passively set, the current market reality is shaped by many products returning to Guangdong from other Chinese provinces. These products cannot be sold entirely in other provinces, and, after losing money several times, the market has grown more astute. Unable to engage in first-hand pricing, it has discovered that short selling can also earn money. Futures buying has a significant disadvantage, however, as it only adds to market turbulence. Neither the buyer nor the seller actually have tea and may even gamble solely on price differences, ignoring actual products. The end result is that market turbulence constantly increases and profits are driven ever lower.

This year's Mengsong Tuo tea is an example of this trend. Before the tea had even been delivered, prices already began to fall and even fell below the prices of factory sellers. By taking advantage of short-sales tactics, the market placed downward pressure on the profits of second-hand sellers and even created numerous examples of products in which they lost money and even the cost of shipping. Through short sales, Fangcun has been able to retake its controlling position. It is able to earn profits when prices rise and also when they fall. Physical franchise stores can only react to market forces. An even more significant factor is the market's increasingly short price cycle, which can affect the choices of speculators and drive investors into retreat. This has thoroughly exposed Puerh's fluidity trap and reduced the ability of investors to convert tea into cash. As a result, risk has increased and affects all quantities and batches of tea. Controllability is too low and so are profit expectations- These factors, combined with increasing storage cycles, have destroyed old pricing principles and have led to Fangcun tea market's current drop in prices.

This year's drop in prices was different than that of 2007, which came after prices had increased by a factor of ten. This time there was no corresponding rise in prices and the drop was comprehensive. It reflected a cooling off in the trade of new tea and a downhill trend in new Puerh tea speculation. Fangcun tea market, which has long served as the engine driving Puerh investment and determining its price, stalled. In addition to high demand for market capital, structural changes were the primary cause. This is fundamentally due to the following three factors:

1. The growth of franchise stores removed Fangcun's ability to set prices. Without favorable prices, it lost the ability to make a good profit. Fangcun market could no longer attract large-scale investment, and speculators did not dare hold onto stock, which led to increasingly brief price cycles and the retreat of capital.

2. Although tea markets have been established in other provinces, they have grown too slowly. Relying entirely on end-consumer sales, they are unable to meet expectations. This has resulted in the return of products from these markets to Guangdong. Development of consumer sales is a long-term goal but requires time. Franchise scores will not be able to fully develop the market unless the return of tea products from other province is brought under control. Otherwise, Fangcun will pay and teas no matter how far away will flow back into the market. Favorable prices drive the market, but when prices fall dramatically it is the market system itself that suffers. A pure trading market such as Fangcun is not affected by rising and falling prices, but this situation docs not benefit the long term development of the market.

3. Futures transactions have become more and more common. Because profits are not high, the focus of transactions has shifted to favor quickly buying and selling products. This has created a situation very much like gambling with increasingly violent and unpredictable price fluctuations. The price of many teas is unrelated to quality. For example, Dayi Zhi Lian is a relatively high quality tea. It compares favorable with other factory teas in terms of flavor and packaging, but its prices still fell significantly because it does not have price support from older products. Guan Long cakes, on the other hand, enjoyed ideal prices in spite of quality that is not necessarily better than Dayi Zhi Lian. Pure market trading destroyed the original value proposition of Puerh tea.

Why do I spend so much time writing about Dayi? Because Dayi is the leading Puerh tea brand, its growth and price changes affect the direction of the entire tea market. Even more importantly, since 2009 market transactions have become increasingly concentrated, and investment is primarily targeted toward Dayi products. Although products of Xiaguan and second-tier factories have seen individual success, they do not affect the overall market situation in the same way. When Dayi prices suffer, they also tend to suffer. This is the power exerted by the largest Puerh tea label.

The situation of 2007 in which many differenr teas enjoyed success is no longer in effect. The five-year-old teas of many second-tier factories are selling for unremarkable prices. The price of new tea is even worse. A very small number of brands have come out on top, but these exceptions just provide further evidence of the market's decline. In 1999 the Puerh tea trade was al/so very concentrated, since it consisted of only two factories, Menghai and Xiaguan, At that time market operations faced serious difficulties, as did the tea factories. From the market's perspective, future growth of new teas is likely to decline and Fangcun must transform itself. It will evolve and find its own way out of its current difficulties.

I've kept track of the changing prices of numerous teas during the current decline and have noticed that, although 2007, 2008, and 2009 7542 prices fell, the scope of these losses was limited and prices were relatively reasonable. Prices were often underestimated and the market did go overboard unloading merchandise. The price of 2006 7542 has also remained stable. Prices of pre-reform teas fell; however, as quantities were reduced, prices stabilized. This is further evidence of the superiority of older tea in terms of risk and stability.

I believe that Fangcun will gradually shift its focus to products three years old and older, and will become more stable, no longer suffering under influence of new teas. Although I am somewhat pessimistic about prices in the short term, this decline in prices does not have space to extend further. Prices are not falling from a high starting point and are only suffering from sales pressure due to short-term disappointment. The prices of many teas have already gradually begun to stabilize. The Dragon cake (Long Bing) released at the end of 2011 is just one example of this trend. Buying Dayi currently carries low risk - primarily due to the weak harvest in fall of 2011. Abnormal climate trends may continue to contribute to sharp deviations in Puerh prices. This past fall saw unusual weather. If experience is any judge, this coming spring is also likely to see undesirable weather. Prices of factories teas are likely to be supported by increasing raw material prices and thus have probably reached a low point.

I believe there arc three trends worth watching as the tea market transforms:

1. Famous mountain tea growth has already begun to assume mainstream status among consumers and prices continue to rise. Future tea consumption will gradually come to be driven by famous mountain teas, as these teas infiltrate the traditional tea buying and tea drinking consumer market. The market for high-priced Puerh tea will also solidify,

2. With decreasing profits and increasing production quantities of name brand tea, the market will gradually shift toward speculation of three year and older tea. Growth of the consumer market in other provinces must rely on the Puerh tea with fundamental value, that is, old Puerh; otherwise, it is difficult to differentiate Puerh from other types of tea. We can see that large tea factories must either reduce production or alter the products they produce.

3. A tea market without investment flowing in and without the ability to set prices will eventually change and find its own solution. Many tea brands have learned that they cannot have everything. They cannot have both speculator and consumer sales. Future changes to factory teas and restructuring of the Puerh sales structure will require fundamental product changes, which are worth watching.

It is said that the Year of the Dragon brings new hope. I know that many people hope that, following the success of the Dragon cake, the market will regain its earlier prosperity. Fangcun market is not fading away; it is simply undergoing a transformation. I believe that, over the course of the following year, Fangcun will find new direction and a renewed atmosphere and, thereby, help drive the growth of the Puerh tea market.