Gold Leads, Bitcoin Follows - CHAINLETTER 50
Through the current bull phase, gold has led bitcoin, with one exception. With fund flows firm, volatility structurally declining and market euphoria cauterised, the bases are loaded.
Meanwhile debasement continues in Japan, while the latest revisions from the Bank of England tell us everything we need to know about the fraudulence of socialism. No wonder the gold price is on a tear.
We have a stab at thinking about valuing Bitcoin as a network effect asset. It’s highly subjective, but it gives an idea of its exponential potential. This will gather pace as and when it is used more. The announcement by Tether that it will integrate USDt into the bitcoin ecosystem could be a seminal moment in this regard.
Technical
With the gold price poking its nose above US$2,900, it’s an interesting moment to compare price performance with bitcoin’s only sound money rival.
The chart below shows how similar performance has been, directionally, since March 2022, almost three years ago.
Apart from early 2024 (2), which is when spot bitcoin ETFs were approved and launched in the US, the pattern has been: gold leads, bitcoin follows.
Let’s follow the trail.
We start in late October 2022 (1). Bitcoin (orange, left hand axis) is still languishing in post-FTX misery, but gold (red, right hand axis) has a sudden bounce. That move announced the start of the current bull market in alternative assets. It took bitcoin until January 2023 to pick up the scent, 2 months after the gold spike.
The prices move more or less in tandem (directionally), with bitcoin taking the lead as it becomes clear that US spot bitcoin ETFs will be approved (2).
Bitcoin then enters a long period of consolidation, and gold picks up the baton (3). In this instance the delay between the gold breakout and the bitcoin breakout is around 3 months.
Bitcoin then goes on a tear (4) as gold consolidates.
Now we are in stage (5). Bitcoin is consolidating those Autumn gains, while gold has made new highs in a hugely powerful move.
As long as you think the pre-conditions for gold’s appreciation will prevail, you can own bitcoin with supreme confidence for the rest of the year based on these patterns. Gold leads, bitcoin follows.
Volatility continues to decline
A quick update on bitcoin’s volatility, often used as a stick to beat it with. Note how the trend continues to decrease, a sign of a maturing asset.
In bitcoin’s case, high volatility has largely been as a result of a lack of understanding. As education and adoption increase, it makes sense that it continues to decline. Not that we care a great deal, mind you. Elevated volatility for an emerging, structurally growing asset is an investor’s friend.
ETF holdings continue to rise
Gold held by ETFs, a measure of institutional involvement, continues to rise, although sits some way below the COVID highs. The driver behind the price has therefore come from elsewhere, presumably central bank buying. Imagine what happens when institutional investors stop putting all their faith in large cap US equities.
Bitcoin held by ETFs, meanwhile, continues to make new highs. There is absolutely no sign of selling as we go through this period of high-level price consolidation.
Buy when others are Fearful
You’re probably nervous about buying bitcoin here. If so, you’re not alone. As you can see at the bottom of the chart, we’re in the brown zone (not a euphemism).
In a bull market this is the time to be adding, as shown in March, July and September 2023, then from May through to October 2024. Obviously, this phase might last for a couple of months, but then again, it might not.
The point is that, regardless of the price, the market is far from euphoric.
On-Chain
Old coins, new buyers?
An alert reached us that 4,500 coins that have remained dormant for over 10 years have moved wallet.
The knee-jerk reaction is that this is something we should be concerned about, since “whales” are deemed good contrarian indicators.
We are not so sure. At a conference last week, Anthony Scaramucci of Skybridge Capital suggested that US intelligence sources think that undisclosed national bodies are accumulating bitcoin on the quiet. However, in a bid to keep this under the radar they are doing this in one of two ways:
-????????? Mining it themselves
-????????? Buying “virgin” coins from miners or other long-term holders
4,500 BTC is worth around US$450 million, so not a ticket size affordable to many. We suspect a sovereign buyer would have to pay a premium. This is the only reason why a strategic holder would part with these coins, for two reasons. First, to mitigate any capital gains that need to be realised. Second, to enable the seller to replenish the position through the market, thereby neutralising the impact of a sale (or make a profit).
This is, of course, speculation on our part. But it rhymes.
Network Effect valuations
One way of thinking about valuing bitcoin is through the lens of Metcalfe’s Law. This is the idea that the value of a network increases exponentially with the number of users. If only one person owned bitcoin, it would be worthless. If four billion people own bitcoin, it’s worth a great deal more.
If we assume that the market is efficient, we can take today’s network value of bitcoin as correct.
What we then need to know is the number of bitcoin holders. There is no accurate figure, so we’re left with a range of estimates. They seem to range from 2-4% of the world’s population (2-3% of the world’s population here and 314m here), so somewhere between 200 and 400m.
Take your pick. The point is that the valuation grows exponentially with greater adoption.
Using Metcalfe’s Law as a guide, what happens to the Bitcoin Network’s valuation as adoption increases? The table below gives a guide. As an example, if 314 million bitcoin owners today gives a valuation of US$2 trillion, 1 billion owners would suggest a network value of US$12.8 trillion, a six-fold increase.
This is just a thought experiment and should not be used as a prediction of bitcoin’s valuation. It’s clearly also highly sensitive to the initial number of users.
But it’s interesting nonetheless, particularly if we consider that day to day usage of bitcoin as a form of monetary exchange is de minimis, and the amount that people own is likely to be a very small proportion of their overall net worth. As the technology improves, so it will become more accessible to a wider audience, and one would expect both usage and ownership to increase on a per capita basis.
Macro
I spoke to a friend in the UK pub industry last week. She told me that they expect their main costs to rise by 7.5% this year.
They’re a small business and it’s really tough. Not only does that mean less profit to share with existing staff, it means less inclination to employ new workers. The latter point is exacerbated by employment laws which now give employees full rights from day one, regardless of how capable or suited they are to the job. It’s a nightmare.
As if State suffocation wasn’t bad enough under the Conservatives, the Labour government has put it on fast forward.
The contradictions in UK government policy are bewildering. How can any sentient human expect strong GDP growth when the drivers of profitability – private businesses – are being shackled in this way? How can any government investment plans be financed when the chief sources of government financing are being throttled? How can you expect private investment when the rules are so stacked against private investors?
No wonder the Bank of England has increased its expectations for unemployment to 4.8% over the next year (a 0.5% increase), while simultaneously lowering its growth forecast and increasing its inflation forecast.
It’s a trifecta of appalling news. At least the Bank of England has cut rates. Well, it’s a tiny cut that comes in the face of an elevated inflation outlook. No wonder investors are adding gold and bitcoin to their portfolios.
Government policy is driving cost inflation, and at the same time slowing investment and growth.
This comes at a time when policy is laying more burden on the state (eg nationalising the railways and forcing children out of private and into state schools).
The next chart is from Truflation which measures inflation on a daily basis. Currently it is running at more than a percentage point higher than the official 2.5% print in December.
This comes against a backdrop of high and rising national debt. Government debt to GDP at 97.6% is back to where it was in the early 1960s, when we were still paying the bills for the Second World War.
The outcome for the ordinary citizen is, inevitably, a declining standard of living. Outside of a small subset, people are struggling. This is not a lower-class crisis, it is an everybody crisis.
Poverty breeds anger, misery and discontent. It is also the seedbed for corruption, not just in the financial world, but in the numerous instances of institutional bullying, leading examples being the Post Office scandal and the blood transfusion scandal, but there are many more besides.
We are slipping rapidly in the global corruption index, as shown below:
This is what socialism brings, accompanied by a mendacious undermining of the national institutions that bind us together, whether it be our universities, courts, church or constitution. It’s all in the name of progress and fairness, but it delivers the opposite: individual and collective decline, while ossifying social mobility.
Changing The Narrative
Yet to suggest otherwise is to be accused of having “dubious politics”. Somehow, the idea that returning power to the people, through Parliament, is regarded as “Far Right”. The central idea of generating prosperity by getting big government out of the way is somehow conflated with Adolf Hitler. Yet these “Far Right” ideas favour a move away from the centre – decentralisation – not an accumulation of power in the centre. This is as un-Nazi as it gets.
Not until this political narrative is turned onto its head can any progress be made.
Incredibly, that seems to have been achieved in the United States following the election. People are no longer ashamed to call out the left and reject their dystopian nannying.
The UK has a good chance to follow suit. The bow wave of change will hit our shores first, but it might take more applied misery to persuade those with luxury beliefs to change their stance.
That suggests continued decline for the time being.
From a macro perspective, continued decline will look like weak GDP growth, high taxes, rising unemployment, above target inflation and a weak currency (possibly accompanied by capital controls at some stage to prevent flight).
Those seeking shelter in government bonds are unlikely to find it.
If you are not considering bitcoin as part of a diversified portfolio for a UK investor, the only reasonable explanation is that you have yet to find out how it works.
Japan inflation
Just in case you were under the impression that the UK is the only country seeing the return of inflation, may we present Exhibit J. Japan.
We can’t pretend to fully understand how things work in Japan, but in the face of this inflationary pressure the Bank of Japan raised its key short-term interest rate by 0.25% to a whopping 0.5%.
While government bond yields continue to rise to reflect this, at 1.3% they are a long way below the rate of inflation.
This is an example of negative interest rates, a classic driver of money into gold and hard assets like property. It is also known as currency debasement.
You might expect the Yen to strengthen as interest rates rise relative to other countries, but the best that can be said is that it’s stopped falling against the dollar.
The much more important wealth-preservation traded for Japanese investors has been to hold gold and bitcoin…
…and property
Cryptoverse
Stablecoins on the Bitcoin Network
We frequently discuss the need for bitcoin to show its colours as a monetary network. It needs to be thought of as more than just “digital gold”.
It’s an important point, because when investors think of bitcoin as digital gold, they conflate all gold’s shortcomings with bitcoin. But bitcoin is a great deal more than that, because it has its own internet infrastructure on which it can operate. Gold needs forklift trucks, bullet-proof vans and battlecruisers to move around.
Good news, then.
Tether, creator of the USDt stablecoin, has announced that USDt will be integrated into Bitcoin’s eco-system. The market value of all USDt is now around US$150bn, by some distance the largest stablecoin, claiming over 350 million worldwide users.
This will be enabled via Layer-2 solutions such as the Lightning Network, which are able to operate at much faster speeds, and are much cheaper, yet use bitcoin’s security and decentralization.
This is a big step in bitcoin’s evolution to become a global payments network rather than just a hiding place for savers. The difference between the bitcoin network and others, like Ripple (XRP), is the element of decentralisation, which renders it incorruptible (and is the central reason why XRP is held in such contempt in bitcoin circles).
Greater usage, of course, will reinforce bitcoin’s value as a network effect asset, which we tackled in the On-Chain section.