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Chinese Maotai Bubble Bursts!

|Includes: DB Base Metals Double Short ETN (BOM), FXP, TAO

For the past three years, China's credit bubble and stimulus fueled growth, along with demand for real estate and luxury goods. The stocks of luxury goods makers in China, including popular brands such as baijiu distiller Maotai (600519.SS) and casinos such as SJM Holdings (0880.HK), have done very well even though the Chinese markets peaked in August 2009.

A recent effort by the government to crack down on Maotai purchases (and wasteful spending in general) seems to be working, but it may also signal a broader economic slowdown. As one example of the waste, one district governor drank 1200 bottles of Maotai last year (see 茅台酒公款招待调查:区政府一年喝掉1200瓶), which at an approximate value of 2000 yuan or about $300 a pop, amounts to some serious change.

A Chinese article asks, "How can the price of Maotai fall?" (茅台怎么降价了?) The price of Maotai typically falls slightly after Spring Festival and this year supplies remain tight, which should only cause a small drop in prices. Instead, prices at supermarkets have plunged 15-30% in the past few weeks as sellers look to unload inventory. The next strong season for liquor is the Mid-Autumn Festival, usually in September, and supermarkets aren't waiting around to move inventory. Normally prices dip a little, but stay high until rising again in September. This is the first time prices have come down sharply for Maotai-and it isn't the only brand suffering. See: "Maotai, Wuliangye and other high-end liquors tumble in price" (茅台、五粮液等高端酒价下跌)

A Chinese article from February 7 discusses the large accumulated inventory of Maotai speculators (who trade bottles of Maotai like stocks) that was keeping prices from rising too much at Spring Festival. (炒家茅台春节集中抛货 节后酒水消费现滞) Now the dam has burst and Maotai is headed the way of the Beanie Babies bubble that accompanied the Nasdaq bubble.

Beanie Babies began to emerge as popular collectibles in late 1995, and became a hot toy.[4] Ty systematically retired various designs, and many people assumed that all "retired" designs would rise in value the way that early retirees had. The craze lasted through 1999 and slowly declined after the Ty company's announcement that they would no longer be making Beanie Babies and made a bear called "The End".
Typical behavior during positive social mood, which often generates credit bubbles that finance an investment craze.

Whether the Maotai deflation is also an indicator for the Chinese economy is hard to say today since the government can be effective with very targeted measures.

I am bearish in general at this time and you cannot underestimate the power of a Chinese government crackdown, at least in the short-run, but even with those caveats this looks like a bad sign for the Chinese economy and coincident with the housing slowdown (either way, woe to the Chinese who started investing in bottles of Maotai). If it's a strong enough signal we should see follow-on bad news in Q2, but if the economy continues along its "soft-landing" path, then the crackdown would look like the best explanation.

Below is a chart of Maotai A-shares. It has a long way to fall......

To add an exclamation point on the Maotai bubble: China Sprouts Moutai Stores

Kweichow Moutai Distillery Co, which own China's best known liquor brand, this year plans to open 130 outlets across the country, a person working in the industry told the EO. The company, which currently has only 30 stores under its own brand, will produce an extra 1,800 tons of the famous white spirit to stock the extra shelves.
A long way indeed.

Some reasons to think this is a sign of a major turn in the economy are the slowdowns in various sectors. The popping of the Maotai bubble isn't occuring in a vacuum, it comes after infrastructure and real estate projects have cooled. See Slow ahead: China puts the brake on freeway construction and City Subway Construction Decelerates in China for two examples. This week's National People's Congress headlines include increased defense spending, more money for education and healthcare, and a reduction in the GDP growth target to 7.5%.

These show the government now places wealth redistribution (closing the growing wealth gap) ahead of growth and policies aimed at cracking down on private lending and out of control local government finances will further deflate credit bubbles. Additionally, the property tax will be expanded to more cities. Currently local governments rely on land sales for the bulk of their revenue, sometimes well over 50%. The property tax is a necessary step forward to stabilize local finances (and close the wealth gap), but it also makes property specualtors less likely to sit still as their deflating empty apartments turn cash flow negative.

If this is a sign of things to come, Guggenheim China Real Estate (NYSEARCA:TAO) will test its 52-week lows in the next few months. Short and leveraged short ETFs such as ProShares Ultrashort FTSE China (NYSEARCA:FXP) and PowerShares DB Base Metals Double Short ETN (NYSEARCA:BOM) stand to benefit.

A decline in the Chinese economy would also be short-term bearish for gold because Chinese demand is nearly one-quarter of global demand and many investors are betting on inflationary scenarios: a slowdown in China would initially unleash another wave of global deflation.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.