Ecoinometrics - August 24, 2020
People are worried about correlations...
There is something you see popping up pretty regularly these days.
Some short term correlation indicator shows that Bitcoin is getting increasingly correlated to another asset and people start to worry about it.
The truth is that over short periods of time Bitcoin is going to get correlated to other assets. Most of the time it is pretty easy to understand why if you look at what is going on in the market.
But the main driving force behind the rise of Bitcoin remains unchanged...
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People are worried about Bitcoin correlation to gold…
Do you remember when people were worried about Bitcoin being correlated to the stock market?
I’ve covered that here back then.
Obviously having Bitcoin quite strongly correlated to the SP500 wasn’t ideal... but it was also totally expected given the price action at the time.
Remember the logic behind it:
In a liquidity event, leveraged traders are hit by margin calls and need to sell their hard assets (Bitcoin, gold, etc...) to raise cash. High correlation.
Then the market recovered. Since everything recovered at the same time the correlation remained high.
Finally the Bitcoin’s volatility crashed which is also more likely to give you a high correlation with the stock market.
Then Bitcoin broke out of a three months tight trading range, volatility came back and as expected the correlation with the SP500 came back down.
As I said, nothing magical is going on here. The explanation is pretty straightforward.
So the problem used to be that Bitcoin was too much correlated with the stock market. Then everybody forgot about it.
Now the problem is that it is too much correlated with gold… but again is that really surprising?
I think not.
Just follow the chart to see the pattern:
The liquidity event snapped the correlation between Bitcoin and gold higher.
Since both gold and Bitcoin have completed their V-shape recovery the demand for hard assets has increased. If you think of Bitcoin as digital gold, it isn’t surprising that both assets tend to have higher correlation. They are driven by the same macro narrative.
But this is all short term.
Bitcoin has a small market compared to gold.
That means:
Bitcoin’s upside is much higher than that of gold.
Bitcoin’s volatility is going to be much higher than that of gold.
I expect both gold and Bitcoin will do well in a macro quantitative easing environment.
However once Bitcoin’s value really starts to skyrocket the volatility and the size of the move should make it so that once again it will have a very low correlation to gold.
There is a long way to go so we’ll see how that plays out.
Bitcoin and the DXY
People are worried about the effect of a strong dollar on Bitcoin.
In case you don’t already know about that DXY, the US Dollar index, is a measure of the strength of the US dollar relative to a weighted basket of other global currencies.
Most of the basket is made of the Euro (60%) followed by the Japanese Yen, the British Pound and the Canadian Dollar (each about 10%).
Now when you understand that you can see that there are two main driving forces for the DXY:
A short term driving force which is how much USD liquidity people need at a given point in time.
A long term driving force which is how much USD is getting printed versus the Euro and other currencies.
So in the short term you can see the DXY rally from 95 to 103 when everyone is getting hit by margin calls and needs USD cash as collateral.
And after that you can also see the longer term effects of the extraordinary expansion of the Fed balance sheet driving DXY from 103 back down to 93.
What’s my point?
My point is that the DXY does not include Bitcoin in its basket of currencies.
All the fiat currencies in the world are racing to see who can do the most impressive Quantitative Easing program.
Meanwhile Bitcoin continues its algorithmic Quantitative Tightening.
That means over the long run you shouldn’t worry about the strength of the US Dollar against other fiat currencies.
The only thing that matters is that Bitcoin and the the USD are on divergent paths when it comes to monetary policies.
A Link marine has fallen…
That was quick. Dave Portnoy’s foray in the world of crypto was short-lived.
Some say this could be good OpSec from Dave to keep a low profile on his Bitcoin holdings… I don’t know about that. Dave Portnoy does not strike me as the type of person to worry about OpSec.
But this (short) story is showing you why you need to have a long term view. The asymmetric bet in Bitcoin is going to play out over the timescale of the halving cycle.
So you just have to be patient.
Dave Portnoy is showing that he does not have a low time preference. Maybe he’ll be back in the game when FOMO really kicks in.
Central banks digital currencies
Here is a good overview of the state of things for central banks digital currencies on Cointelegraph.
There are of course many risks in the implementation of CBDCs: security, privacy, even more ways for the central banks to mess up monetary policies...
But I think this quote from the article is a good summary of the big issue with central banks digital currencies:
“Digital currencies are cheap or sometimes even free to produce once the underlying code is there.”
Bitcoin solves this.
If you have learned something don’t forget to subscribe to the newsletter to get my insights directly in your inbox.
Cheers,
Nick
The Ecoinometrics newsletter decrypts Bitcoin’s place in the global financial system. If you want to get an edge in understanding the future of finance you only have to do two things:
Click on the subscribe button right below.
Follow Ecoinometrics on Twitter at https://twitter.com/ecoinometrics.
Done? That’s great! Thank you and enjoy.