Investing in precious metals versus cryptocurrencies

Commodities have long been considered by investors to hedge inflation and of the raw materials, gold has usually been presented as the best inflation-hedging asset. But investors need to understand that commodities are not a homogeneous asset class, and rather than a mere reaction to inflation, they need to take various market drivers affecting natural resources into account.

Let’s consider gold. The yellow metal lagged almost every other commodity during the recent rally in raw materials' prices since 2020. It is true that the gold price touched $2,050 per ounce in March 2022, but in real terms this is below the high of 2011, that would be equivalent today to around $2,300. And if we take the high inflation of the 1970s, as a benchmark, that would now be almost $2,950.

The underperformance of precious metals in our view is partly due to a new competition from the rise of the cryptocurrencies. From March 2020 to November 2021, the size of the cryptocurrency market surged more than 19 times to $2.9tn. Bitcoin’s price increased from a low of about $3,800 to a peak of about $69,000 by November 2021. That is, more than 18 times from trough to peak. Other cryptocurrencies, such as ethereum, did even better.

Cryptocurrencies attracted investors, many in the younger bracket who were not particularly tempted to invest in gold, with some seeing the mining industry as both dirty and outdated. Some crypto fans were drawn to a similar libertarian narrative as the gold investors, but with the added allure of a decentralized asset having no physical presence. Others liked the technological aspect of blockchain compared with a simple piece of metal.

Of course, the size of the gold market is nearly four times that of the cryptocurrencies market at the peak at $11tn, and the shift in monetary policy has led to a sharp correction in crypto markets along with the tech sector stocks. Since 2020 gold has been consolidating in a tight range of $1750 - $2000 per ounce. Meanwhile, other commodity markets including energy, metals and crops, have been rallying largely due to the fundamental factors affecting supply and demand of the actual materials. These include aggressive biofuels policies, the energy transition, bad weather affecting crops, the Covid pandemic, and geopolitical risks due to Ukraine-Russia conflict.

These underlying factors have been behind the widespread strength in most commodities markets, alongside an increase in money supplies that drove inflation to unpredicted levels. But market moves in commodities including inflation-led rallies which are not caused by supply and demand changes are less intense. As such, it is important to remember that energy, industrial metals, precious metals, minerals, and crops have their own dynamic.

Although long-lasting commodities bull markets generally tend to be based on fundamentals, inflation can undoubtedly help in adding strength to such a rally. Energy and precious metals correlate better in some specific periods with general price increases. As ever with investing, timing is everything. An adjustment upwards in inflation expectations may incentivize a rush to commodities. Therefore, since the beginning of the year 2022 we saw solid rally in energy, and food prices. If you enter a position before such a change and fundamentals support the rally, the strategy will work. But if you build the position too late, once future inflation is discounted and fundamentals start adapting, be ready for losses. A strong correlation of commodity prices and inflation is not enough to guarantee a good passive hedge to protect your investment portfolio. Undeniably, there are reasons to buy some commodities for hedging purposes at specific times. However, fundamental drivers of this complex asset class should always be considered, and trading must not just be a mere reaction to inflation. So far, investors understood that cryptocurrencies do not offer any kind of inflation hedge or portfolio protection. But what about gold? Is it the right time to turn back to gold? At least one fact we know for sure - gold price is much less volatile than that for cryptocurrencies; and therefore, could add much more stability to an investment portfolio from diversification point of view.