The great 2021 Bitcoin (BTC) and crypto crash has brought to light a number of interesting factors relating to the gold market, its correlation to the BTC price and the response of our equity markets.
Today, I’ll be looking at how these factors seem to affect each other and what that this could potentially mean for each of these asset types.
There are two questions that I think will need to be considered going into the rest of this year.
Firstly, is the rally in gold an indication of inflation fears or hedging for an overheated equity market? How does this rally relate to crypto?
Secondly, will cryptocurrencies recover at some point and become an institutional-grade asset thereby giving it a foreseeable future?
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Why the rally in gold may not be a warning sign this time
Since the beginning of this year, there has been a strong negative correlation between Bitcoin and gold (red graph at the bottom), going as low as -0.80 from April onwards.
In normal times, gold should rally when there are inflation fears within the markets.
However, what we saw from August last year to April this year is a sell-off in gold.
This is unusual as inflation fears were at historical highs due to the huge amounts of stimulus that the global economy was receiving.
The high in gold coincided with a 20% rally in the BTC price, which led to the start of the $12,000 to $64,000 rally a few months later in November until its top in mid-April.
From the correlation between the two assets, it looks like some investors were using BTC as an inflation hedge in lieu of or on par with gold.
This was further exacerbated by the free money from stimulus checks which caused a positive feedback loop, pushing the BTC price to astronomical heights.
What’s more interesting though is that this correlation has continued to hold true, with the rally in gold since mid-April coinciding with a high in the BTC price and subsequent crypto crash within weeks of each other.
Even though hindsight is always 20-20, it seems the more astute investors have picked up on this correlation and forecasted the weakness and the subsequent sell-off in cryptos, thereby rotating back into gold weeks ahead of the crypto crash.
What this also tells me somewhat, is that the recent rally has been rotation driven rather than fear or inflation driven.
The rally in gold this time seems to be just gold making up for lost ground this year as investors rotate out of Bitcoin (BTC) back into the yellow asset, rather than a large rise in investor hedging and fear.
All things being equal, I think the equity markets will continue to be stable heading into the next few months.
Will Bitcoin (BTC) and crypto recover?
It is unlikely the BTC price will be able to recover to its all-time highs any time soon.
The rally from $12,000 to $64,000 was driven mainly by stimulus checks and what looks to be a rotation from gold.
Now that the stimulus checks have been spent and lost and gold traders seemed to have rotated back to the yellow metal, I believe a recovery will now depend on two main factors – institutional participation and regulation.
Factor 1 – Institutional participation
Firstly, was there really a high rate of adoption by institutional investors?
I don’t believe so. If there was strong institutional participation as some proponents of crypto have been saying, a sell-off of 40-50% should see liquidation in other assets to cover margin calls triggered by the crypto crash.
This does not seem to have been the case.
It is likely the most participation we have seen so far is a small allocation of risk assets with similar characteristics (i.e. gold) into crypto as diversification, if any.
This is further evidenced in the strong correlation between gold and Bitcoin (BTC).
This leads us to the first main driver of institutional participation.
The first use case for crypto in an institutional setting centres around the asset been similar in characteristics to gold.
Both of these assets don’t produce an income, are speculative in nature and the limited supply is suppose to be a hedge against fiat debasement.
However, a crash such as this can cause a significant loss in confidence as the volatility continues to be much too high for it to be a dependable asset class.
The crypto crash also came at a time when inflation fears are historically high and where markets have been calm, meaning its use case as an inflation hedge hasn’t panned out too well.
The second use case for Bitcoin (BTC) is the asset becoming accepted as a mainstream means of payment thereby making it astronomically more valuable than what it is today.
This I have always found to be highly unlikely and that has been my view since at least 2018.
There have been two significant developments regarding this in just the past few weeks.
Firstly, Tesla’s about-face on their position with Bitcoin has put a serious dent in the momentum of potential acceptance of the coin.
It can be said that the sparse number of larger firms such as PwC that do accept Bitcoin as payment did it as a marketing exercise – it is hard to disagree with this view considering Tesla’s recent actions.
The reversal in Tesla’s decision will put further doubt into institutional minds as to the viability of using Bitcoin as a form of payment.
The second development is regulation.
Factor 2 – Regulation
Regulation is a huge, if not the most important, factor in cryptocurrency becoming mainstream.
We have had two significant factors develop recently, with China’s crackdown on the asset and regulation by the US.
China usually doesn’t do things in half measures. If they say they will crack down on cryptocurrency mining and using it as a form of payment, it’s likely already halfway there if not already done.
This is a huge blow as a large number of miners and BTC sit inside China.
It is likely we will see a lot of miners selling their gear as well as their mined, low-cost BTC to cover overheads – these short term headwinds will be considerable.
The US is also seeking to have cryptocurrency transfers of over $10,000 be reported to the IRS.
This will have a significant effect on the value of anonymity that cryptos offer, taking away one of the main pros of using crypto in the first place.
This factor in particular is not temporary, and it will only get worse.
An apt analogy for this would be to steal a line from Game of Thrones: Regulation is coming.
Key takeaways
The correlation between the BTC price and gold is too strong to ignore and I believe that gold price is just catching up to where it should be, after the extreme crypto hype we have seen in the past few months.
I don’t think the rally in gold is a sign to come for future equity market volatility and is simply a rotation of assets, at least for now.
In terms of a recovery in crypto, lack of stimulus checks, hesitation in institutional adoption and regulation will continue to cause a huge dampener in the recovery of Bitcoin or any of the major cryptos back to their all-time highs.
Watching the developments in regulation will be key.
