Crypto Market Commentary 

21 August 2019

Doc's Daily Commentary

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Mind Of Mav

Bitcoin’s Emerging Role As A Global Hedge & Safe Haven Asset

Bitcoin is often touted as a hedge against, well, everything. The dominant narrative is that, eventually, global central bank’s ad infinitum money creation will come to a glorious end and crypto-currencies will finally have their day in the sun. Of course, precious metals are often touted as “barbarous relics” and will certainly not be in competition for this hypothetical “new world currency”.

I have many doubts about that narrative specficially.

If U.S dollars suddenly became worthless tomorrow, it seems the last thing people would do is trust a nascent technology to hold thier wealth — like it or not, crypto and fiat are stuck with each other. We need more maturation as an asset class. 

Nevertheless, I do see bitcoin and crypto-currencies in general as a possible portfolio benefit due to their low correlation to other assets and rising status as a “safe haven” asset.

There has been a lot of speculation over the macro-fundamentals of bitcoin. As a primarily top-down analyst, I think it’s high time we try to separate myth from reality and find Bitcoin’s true place in the economic machine.

Myth: Gold and Bitcoin Compete Directly

There are two groups that hold essentially the same macroeconomic view but tend to be opposed to one another: precious metals and crypto-currency investors. Both tend to hold the view that fiat currencies will eventually break, but differ in whether the alternative currency ought to be physical or electronic. Of course, the debate tends to age-aligned with younger people vying in favor of digital currency and older people in favor of the classic yellow metal.

The statistically reality is that gold and bitcoin are usually positively correlated and becoming more so by the day. Here is a chart of the rolling-year correlation between the daily percent changes of Bitcoin and the Gold ETF (GLD):

(Data source: Yahoo Finance)

Here we can see that in Bitcoin’s infancy (which essentially lasted until 2016, when it became widely known), it had essentially no stable correlation to gold. Since then, the correlation has risen, fallen, and since November 2018, has been trending toward a new all-time high.

Now, a 0.20 correlation is generally low but is still statistically significant. It makes sense: currency “race to the bottom” competition has come into vogue following the crash in October of last year, and demand for alternate currencies is rising.

From a very high-level view, the two are highly fungible. Like Bitcoin, most of the world’s “gold” only exists on paper, and if everyone asked for delivery, then there would not be enough. Both will also gain from a theoretical future decline in fiat currencies, and both are in fixed supply.

Overall, as financial turmoil continues to wreck the markets, I would not be surprised if this correlation continues to rise. There is ample evidence to support the hypothesis that Bitcoin is becoming a “defensive” asset. Take a look at the rising correlation between Bitcoin and long-term treasury bonds (TLT) below:

(Data source: Yahoo Finance)

This rolling correlation is weaker than the Gold-Bitcoin one, but serves a similar point that “risk-off” allocation interest in it may be growing.

Alternatively, one could make the logical jump that lower interest rates may also be supportive of a higher Bitcoin. The rise in positive correlation between Bitcoin and treasury bonds was also found in Treasury Inflation-Protected bonds (TIP) and short-term treasuries (SHY). Lower interest rates should, eventually, boost global currency volatility, which helps explain the recent rise in Bitcoin, gold, and sovereign bonds.

Possible Fact: Bitcoin is a Hedge Against the Economy

Overall, the crypto community is uncertain about the relationship between equity markets and cryptocurrency. On one hand, bitcoin benefits from the same excess economic liquidity as stocks, as seen in their conjoined 2017 rally. On the other, Bitcoin is not tied to the “economic growth” underpinning of the equity markets and can be viewed as a “safe haven,” albeit volatile, asset.

Let’s see what we can do to settle this debate. Here is a chart of Bitcoin’s rolling correlation to the S&P 500 (SPY):

(Data source: Yahoo Finance)

Overall, this correlation pattern is less statistically significant than the other two but does follow a logical pattern. If you’ve been following, you may have noticed how there was bit of a regime change early this year wherein it became a “risk-off” asset. As an example, it has been documented by Bloomberg that Bitcoin has seen increased demand in Argentina and Hong Kong amid financial turmoil in those places.

Right now, the correlation stands at -0.09 and is rapidly declining. That figure would need to be at -0.15 to definitively say “bitcoin and equities are negatively correlated,” but it seems that will occur soon.

Myth: Bitcoin Gains From Currency Volatility

At least, not yet. It is widely believed that when currencies become unstable, people will turn to bitcoin. Indeed, Bitcoin is being used as a wealth protectionin some EMs like Venezuela and Zimbabwe. That said, currency volatility from the developed world is statistically neutral, if not negative, for Bitcoin.

To measure this, I made a measure of average currency volatility for the euro, yen, Canadian dollar, British pound, and Singaporean dollar and measured the rolling correlation to Bitcoin.

Here is the result:

(Data source: Yahoo Finance)

The reality is that there is no apparent relationship between the two. In general, the rolling correlation measure is negative, but because “currency volatility” is not stationary, we would need to see a correlation of about 0.25 for statistical significance. That said, we can say with certainty that today, currency volatility is not supportive of Bitcoin prices.

How about emerging market currencies? There may be a negative relationship between the Chinese yuan (CYB) and Bitcoin:

(Data source: Yahoo Finance)

The measure has been relatively consistently negative. Late last year and into this year, it did have a brief jump into positive territory, only to fall back to the negative zone following China’s recent currency devaluation. This supports the hypothesis that Bitcoin may be more relevant for emerging market economies that are subject to higher currency manipulation than those in the developed world.

Bottom Line

Like the correlation of Bitcoin with other assets, the debate regarding Bitcoin’s place in the global economic machine is unlikely to come to a definite conclusion soon. Overall, Bitcoin does seem to be developing a spot among “haven assets,” as witnessed by the sharp movements in correlation this year.

How can we reconcile these empirical results with the prevailing narrative? Perhaps Bitcoin has been rising in concert in gold not because they both respond similarly to the same macroeconomic and geopolitical factors but because Bitcoin has already experienced an 85 percent drawdown (historically the bottom of previous cycles) in combination with Bitcoin-specific factors like the news of Facebook launching its own cryptocurrency and continued institutional interest.

Still, this explanation does not fully explain the entire range of observations. Certain specific geopolitical events, not priced in by market participants, have caused strong intra-day movements in both Bitcoin and gold. Some of the most compelling of these events include Donald Trump’s presidential election, the Brexit referendum, and most recently the depreciation of the yuan in response to growing U.S.-China trade tensions. Such events suggest that the relationship between Bitcoin and gold is market regime dependent.

Under normal times, gold is responsive to standard macroeconomic variables, particularly changes in real yields. Bitcoin, an asset still in the process of maturing into a full-fledged asset class, is unresponsive to macroeconomic data. This explains the typically low levels of Bitcoin-gold correlation that oscillates around zero.

During times of heightened geopolitical risk, the desire for the stability of haven assets takes center stage over the macroeconomic situation. Under such circumstances, the intrinsic qualities of both Bitcoin and gold attract capital and can experience short-lived periods of high correlation.

The reality is that there is a global trend toward investors and individuals wanting to hedge their wealth away from the hands of their home country’s government. Instability in the currencies of emerging market countries is nothing new but has increased in recent years. Interest rates have fallen to extreme lows and stocks have become expensive, particularly considering the economic slowdown. So, where do we put our money? Do we put it all in precious metals? Perhaps, but even then, it is not like the prudent investor to put all of his eggs in one basket.

Overall, Bitcoin is becoming a viable alternative asset. It is not becoming an alternative to gold but a complement to it. Personally, I think Bitcoin’s recent rally will end in another sharp decline because it may still be tied to global liquidity needs. Remember, gold fell with the market in 2008 because investors needed to make margin calls. I would not be surprised if some portion of the Bitcoin ownership base does have risky investments that may force them to sell the cryptocurrency. However, over the long run, I think it is safe to say Bitcoin is here to stay and has at least a small place in our portfolios.



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