Inside China's garlic bubble

(Fortune) -- Garlic has always been revered in China -- not so much for its overpowering bite but as an important ingredient in cuisine and related health benefits. The philosopher Confucius was so fond of the pungent plant he even extolled its virtues in the Shih Ching, the oldest anthology of Chinese poetry.

But never in its long and varied history has garlic been more coveted in China than today, where a speculative bubble has forced wholesale prices to increase 605% to $1,200 per tonne from March 2009 through February 2010. Garlic was the best performing commodity in China in 2009 -- and is set for a repeat performance in 2010.

"Local investors have made serious money in garlic," says Jerry Lou, a China strategist at Morgan Stanley in Hong Kong. Indeed, crude oil and gold futures -- widely regarded as the aristocrats of the commodities world -- climbed 100% and 27% respectively over the same 12-month period. Similarly cocoa and soybean futures, all more widely traded than garlic, improved 42% and 13%.

"It's been a great bull market for commodities across the board," says Larry Schneider, director of business development at Zaner Group, a Chicago-based brokerage firm specializing in futures and commodities. "But I can't remember when anything last shot up like this."

The garlic bubble's roots trace back to 2008, a bad year for garlic producers around the world, with many losing money due to a market glut that pushed prices down. As a result, China, which is the world's No. 1 supplier, cut its output by half in 2009.

At the same time, the swine flu epidemic pushed demand through the roof, because the Chinese view garlic's mild antibiotic properties as protection against infection. In combination, these two factors created the ideal situation for speculators to start a fire under garlic that has continued.

"By May garlic may be completely sold out in China," says John Huang, overseas representative for Jinxiang-based Yafod International Ltd., whose Pretty Garlic brand is his industry's equivalent of Nike or Coca-Cola.

He expects prices to plummet to as low as $600 per tonne in June, when the new harvest hits the market, before rebounding to as high $1,300 with the help of speculators before the year's end. That's not as big a gain as last year, but the potential for big returns is still there.

Unfortunately, foreigners have no way of profiting from China's garlic bubble. That's because, unlike sugar and cocoa, there is no futures market for this oddball commodity. Instead, speculators need to buy up as much produce as they can from individual garlic farmers in the local yuan, load up trucks and store their loot in warehouses, hoping to squeeze supply and drive prices up further.

This kind of price-fixing is having ripple effects around the world, including the U.S. where about 50% of the raw garlic consumed comes from China. U.S.-grown garlic, which sells at a premium because it is more potent, has appreciated about 70% in the last 12 months, says Bill Christopher, co-owner of Gilroy, Calif.-based Christopher Ranch, the biggest domestic supplier of raw garlic in the U.S. "Nobody made money on garlic a couple of years ago," he says. "With what's happening in China, we're profitable again."

While the Chinese government has a reputation for holding its economy on a tight leash, it appears to be unfazed by the rampant speculation in garlic. "There's nothing the government can do," says Huang of Yafod International. "There are many millionaires in China who want to invest their capital."

Let a million garlic bulbs bloom.