Gold and Bitcoin Test Times


By Geoffrey Smith – These are trying times for the dollar alternatives prophets.

After nearly two years of furious money printing to keep the US economy going through the pandemic, it appears the US Federal Reserve is increasingly open to aggressive action to defend the value of the global reserve currency .

This is bad news for anyone who bet that the pandemic would herald the definitive debasement of fiat money. Cryptocurrencies, led by, are at over 40% of their highs of last year, while – the more traditional “store of value” asset – is down nearly 10%. And the news – for them at least – is likely to get worse before it gets better.

Inflation hedges work best not when inflation is highest, but when the central bank is seen to be furthest ‘behind the curve’, too slow to stop a chain of events in which wages and prices continue to rise.

Surely that moment is over when Fed Chairman Jerome Powell told Congress in early December that it was “time to withdraw” the word “transitional”. The central bank previously believed that the consumer price distortions generated by the pandemic would correct themselves in less time than it took for interest rate hikes to have an effect on the economy.

Since December at the latest, the Fed has been in catch-up mode, speaking loudly to persuade the market that it will not let the dollar lose value. Powell told the Senate when confirming his second term with the Fed on Tuesday that he would not let inflation become. This message is more important than the 40-year high that US inflation likely reached in December.

The market only reluctantly began to take these commitments at face value, but is now starting to make up for lost time. According to Fed data, market expectations for inflation in five years peaked in mid-October at 2.4%. They had already fallen to 2.15% at the end of last week.

Bitcoin’s underperformance against gold during this period – after an equally marked outperformance over the past 12 months – has led many to conclude that digital currencies are not hedge assets at all, but rather risky assets, which move more in line with stocks and other speculative investments. .

In a note to clients on Monday, Morgan Stanley analyst Sheena Shah pointed out that Bitcoin has traded with a positive correlation of 0.34 in the past six months (a correlation of 1 would represent a perfect overlap), whereas it tended to evolve in the opposite direction. direction towards gold. The negative correlation here was 0.1.

Shah illustrated that Bitcoin in particular appears to be most closely correlated with the world’s M2 money supply – a relationship that has held steady over the past eight years. This is a clear wake-up call for crypto at a time when central banks representing more than half of the world’s money supply are tightening monetary policy.

This can frustrate anyone who has bought crypto for their wallet in the hope of diversifying their risk, but the point is that wallets in general have become significantly more leveraged over the past couple of years thanks to free money from central banks. . Margin balances tracked by the U.S. Financial Industry Regulatory Authority (FINRA) alone have increased 63% in the two years since the start of the pandemic to nearly $ 920 billion. Higher interest rate compression increases the cost of holding any asset leveraged, and crypto – without coupons or dividends to generate returns – is particularly vulnerable to such cuts.

The same is of course true for gold. JPMorgan analysts estimate it will be back to $ 1,520 an ounce – about 16% below current levels – by the last quarter of this year, as rising real yields encourage a switch to bond yields of income.

The difference, however, is that the gold use case is so much better established. Data from the World Gold Council suggests that the two broad categories of end buyers – jewelers and central banks – both reverted to net buyers at the end of 2021. Purchases by Indian jewelers have exceeded pre-market levels. pandemic in November, while China’s gold imports hit their highest level since 2019 in October. Central banks in advanced economies were net buyers of gold in November for the first time since 2013.

The use case of Bitcoin, as we have already explained here, is quite less convincing. The only functions where it consistently outperforms fiat money in terms of ease of use are, even now, after a decade of rapid and well-funded innovation, illicit transactions, such as ransomware attacks and money laundering. . Short-term demand is driven by momentum or, in other words, speculation.

In the medium term, better regulation and a growing ecosystem for related assets such as NFTs could further broaden crypto’s use case to a degree that places a firmer floor under its valuation. Generational shifts may also mean that this segment of the population that simply does not trust banks and central banks will eventually migrate from Keynes’ “barbaric relic” to digital assets.

But in the short term, neither of these assets looks likely to perform particularly well. The best that can be said is that the downside is more clearly limited for gold bugs than for crypto bros. Gold is best supported by fundamentals, dynamics, regulatory certainty and, most importantly, history. While crypto is about to be tested for the first time by a particularly acute tightening cycle, gold has withstood each of these cycles since the dawn of civilization.

Daniel K. Denny