Gold is definitely more than «physical bitcoin»
Comparisons between gold and bitcoin don’t hold. The yellow metal surpasses bitcoin in presence of high inflation and elevated geopolitical risk. In real crises, the two assets are negatively correlated.
When push comes to shove, investors do seek safety in gold. They don’t seek it in bitcoin or other cryptocurrencies – they drop them instead. While gold is up 6% year-to-date, bitcoin is down 20% and cannot be considered «digital gold».
Gold price in USD hit a nine-month high on February 22.
If the Fed withdraws its heavy hand from markets, it will allow every asset class to live by its own virtues instead of relying on excess liquidity. Inflation has proven to be real and lasting. The outlook for monetary policy is unaccomodative. Geopolitical risks are very high given the tensions between Russia and Ukraine. This is a period when investors seek tried and tested safe havens.
Covid was bullish for the financial markets
Bitcoin was in favor during the Covid crisis because investors weren’t seeking safety. Covid was bullish for markets. After a very brief turmoil, assets got the boost of their life from the trillions of dollars injected by central banks. Investors, backed by the Fed, could afford a high degree of risk. If anything, this episode has revealed the stark difference between gold and bitcoin during market booms: gold gained 16% over two years, while bitcoin shot up 270%, thriving much more on the speculative craze.
Patterns have become clear over time. As we observed in a previous column, the two asset classes react in opposite ways: bitcoin takes in all the speculative air when markets are bullish and when borrowing is in full force, but it corrects much more than gold and even stocks during downturns. On the other hand, gold trades boringly within a flat range during bullish markets, but goes up in uncertain times, as can be seen on the chart of this ZKB gold tracker:
Performance of the ZKB Gold ETF AA in Swiss francs.
Seeing similarities between gold and bitcoin was never the right line of thinking. Neither can bitcoin be called digital gold, nor can gold be called physical bitcoin, as their properties are worlds apart. Inflation is the key element making the difference.
Gold and bitcoin over the last year: negative correlation confirmed.
Rising inflation led to disconnect between gold and bitcoin
Since inflation started rising last summer, gold was disconnected from bitcoin and from global markets, which dropped on inflation fears, while the precious metal rose. Logically, the outlook is good for gold, which remains the best inflation trade. True, higher interest rates can eventually make bonds more attractive than gold. But will interest rates rise this much? Rates cannot go very high, despite the inflation risk. The most likely scenario is that inflation will stay ahead while nominal interest rates will keep lagging and stay behind the curve, and this will push investors to seek refuge in hedges like gold.
Why will interest rates most probably remain behind the curve? Because of market debt. Investor margin debt still is very high. On this advisorsperspectives.com chart, we can see that the negative credit balance on investor accounts for the S&P 500 (shown in red) is still very big. Margin debt is down 8.8% in January from its peaks, but much bigger than in 2018 for instance, when the last tightening was attempted by the Fed - and failed.
Raising interest rates in times of debt
An important point is that gold is also traded on margin. But one has to distinguish between safe-haven buying and speculative buying. At the moment, it is the first and not the latter that is driving gold prices up. As to stock markets, they are heavily dependent on margin trading. The Fed hopes to give time for markets to deleverage. Obviously, however, markets aren’t getting ready for tightening.
In 2018, the Fed increased interest rates from 1,5% to 2,5%. But short-term credit markets (essentially the repo market) couldn’t bear interest rates at this (still low) level, and started showing signs of major liquidity stress. This is the limit that was seen and tested in 2018, when Jerome Powell had to quickly stop tightening and start easing again in September 2019.
On the above graph, you can see that the negative credit balance was considerably smaller in 2018 than it is today, and even then, tightening failed. U.S. markets had shown signs of stress even though investors were less indebted than they are today.
U.S. Federal Fund Rate history.
The Fed’s balance sheet keeps growing
Another indicator that shows how unprepared markets are, and how far the Fed still is from actual tightening, is that its balance sheet keeps growing right now, which is an inflationary monetary creation that goes in the wrong direction. In 2018, things were very different as the Fed was attempting quantitative tightening (balance sheet shrinking). As can be verified on the graph below, the liquidity conditions today are much easier than in 2018 and are still clearly conducive to more inflation:
Fed balance sheet, in trillion dollars.
These are all conditions for further gold appreciation. Gold’s price appreciation so far is halfway from what it gained during Crimea’s annexation by Russia in 2014, or more precisely, it only gained 4/7th of what it gained back then. But even if the ascent of the gold price is countered by geopolitical de-escalation in coming days, inflation is another war still waiting to be fought, and this one isn’t going away.
