by Richard Bernstein, Richard Bernstein Advisors
Cryptocurrency enthusiasts like to refer to Bitcoin, Ethereum, and other cryptocurrencies as “digital gold.” But do cryptocurrencies and gold really play similar roles in portfolios?
Our research suggests cryptocurrencies and gold are not similar asset classes. Cryptocurrencies act like speculative investments driven primarily by financial liquidity conditions, whereas gold appears to be a ballast against uncertainty.
In fact, gold might be a hedge against a cryptocurrency bear market.
Low Correlation
If cryptocurrencies were indeed digital gold, then the correlation between cryptocurrencies and gold should be reasonably high. That is not the case.
Chart 1 shows the correlations between Bitcoin and various asset classes using monthly returns over the past five years. The speculative nature of many markets over the past several years has caused asset correlations to rise, thus limiting the number of potentially diversifying asset classes.
However, the correlation to gold is 0%, which suggests there is virtually no relationship whatsoever between “digital gold” and actual gold. Uncorrelated assets, like gold is to Bitcoin, are typically good diversifying assets.
Liquidity drives cryptos
Excess liquidity is typically a driving factor for speculation and bubbles. Simply put, it’s hard to speculate when financial conditions are tight, lending is constrained, and the economy is contracting (i.e., does one speculate or buy groceries?). However, risk-taking increases as financial conditions ease, lending expands, and overall economic liquidity grows.
We’ve highlighted many times that today’s easy financial conditions question the need for the Fed to cut rates as aggressively as the market has been anticipating. The barriers to borrowing are already low, so the Fed cutting rates could simply mean more inflation or more speculation.
Chart 2 shows the relationship between Bitcoin and the Bloomberg Financial Conditions Index. It seems clear that liquidity has been a driving force of the crypto bull market. Chart 3 shows the close relationship between Bitcoin and high yield corporate bonds. Historically tight credit spreads have been suggesting lower quality bonds’ performance is also being driven by liquidity.
Uncertainty drives gold
Uncertainty, rather than liquidity, seems to drive gold returns. Chart 4 shows the relationship between the National Federation of Businesses Uncertainty Index. The NFIB surveys small businesses across the United States, and their Uncertainty Index corresponds to the level of uncertainty across many business topics like employment, pricing, capital expenditures, financing, and the like.
It seems the recent rally in gold can be attributed to the high levels of uncertainty in the economy.
Gold does not typically behave as a momentum/trading asset class. Rather, our multi-asset portfolios tend to hold a rather static allocation to gold as a ballast against uncertainty. The relatively static gold allocation reflects that “uncertainty,” by definition, can’t be predicted.
Crypto isn't digital gold
Despite the hype, cryptocurrencies are not digital gold. Rather, they are speculative investments that are largely fueled by liquidity conditions. There is nothing inherently wrong with speculative assets, but it seems increasingly disingenuous for cryptocurrency investors to suggest that cryptos currently serve any other purpose beyond speculation.
Gold has historically been a hedge against uncertainty and has such a low correlation to cryptocurrencies that gold might be a diversifier to cryptocurrency portfolios.
But cryptocurrencies are NOT digital gold.
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