The Serious Money in Tulips

In the late 16th century, Holland, and especially Amsterdam, was in the grip of Tulip Mania'. Frantic speculation in tulip bulbs drove prices to such levels that a bulb was worth more than a mid-sized house. Then, as bubbles always do, the tulip bubble burst, leaving many speculators both penniless and homeless. Since then, no one has dared seriously suggest investing in tulips again: even the suggestion of doing so is often enough to provoke the most violent response. But times have changed, and today there really is serious money to be made in tulips for those who are willing to do their homework.

Investing in tulip bulbs is not that different from investing in stocks or bonds. It all depends on what you buy and when. To do this successfully, one has to know a bit about tulips and the way they are grown. Tulips are one of the hardest flowers to breed and grow. Breeding new tulips is necessary because existing breeds genetically degenerate over time, which makes growing them economically unviable. This degeneration occurs because every year the best bulbs are used to grow flowers from, leaving the second-rate bulbs for the year after. New breeds result from cross breeding as well as mutation, but this is a very slow process as, on average, tulip bulbs only multiply by a factor of 2.4 a year. Thus it takes about 20 years before a new tulip reaches the consumer. This makes the breeding of new tulips highly capital and labour intensive, which implies a clear need for financing, and thereby an opportunity for investment.

Investing in completely new tulips is risky as it takes about ten years before specialists are able to tell whether a new tulip is suitable and strong enough for commercial use. The market for new tulips aged between zero and ten years is therefore best left to industry participants, who have a wealth of knowledge and experience in this area. Tulips older than ten years, however, can make very good investments. How good depends on two things: the growth factor and the price drop. The growth factor relates to the speed at which bulbs multiply. On average, one can expect to get 2.4 new bulbs for every bulb planted. Over 2001 and 2002, however, the growth factors were 2.56 and 2.65 because the weather conditions were favourable. The price drop relates to the fact that the price of bulbs typically drops over time as every new harvest creates more of each type of bulb. On average, prices in one year drop to about 62.5% of those in the previous year, but there can be quite a lot of difference between years as well as between types of tulips. In 2000, for example, average prices dropped to 58.5% of those the year before, while in 2001 they only dropped to 72.8%.

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Clearly, investors prefer a high-growth factor and a low price drop. Unfortunately, the growth factor cannot be controlled as it is 100% weather dependent. This is not the case for the price drop, though. Tulip bulbs are primarily traded by means of forward contracts, ie contracts in which the price per kilogram at which the seller will sell (and the buyer buy) next year's harvest is fixed in advance. This means that investors can fix the price of their bulbs for next year, and eliminate price risk. So what do prices for next year look like? With most trading now over, it appears that the average price drop will be around 68%. Taking into account the costs of planting, growing and harvesting, this means that, even if the harvest is now bad, offering a low growth rate of say 2.2%, investors will make a very healthy return of around 15% this year. With a normal or better harvest, this figure will be higher. With a growth rate of 2.75, for example, investors can expect a return of almost 30%. Not bad in a world where one gets at best 3% on a savings account.