Ecoinometrics - July 06, 2020

Correlations...

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:

  1. Click on the subscribe button right below.

  2. Follow Ecoinometrics on Twitter at https://twitter.com/ecoinometrics

    Subscribe now

Done? That’s great! Thank you and enjoy. 


Correlations

You probably have read that Bitcoin is getting more and more correlated to the SP500 and that it’s a bad thing. I’ve seen that too so I decided to take a look.

In case you need it let me refresh your memory about assets correlation.

You look at the daily return of two assets, say Bitcoin and the SP500. We want to say that those two assets are correlated if they tend to move in the same direction at the same time. Over a given period we can summarize that with a number called the correlation coefficient or just correlation of those assets.

So we have three values to keep in mind:

  • If the correlation is +1 then those two assets are always moving in the same direction.

  • If the correlation is -1 then those two assets are always moving in opposite directions.

  • If the correlation is 0 then there is no relationship between how these assets are moving.

The holy grail of investing is to get in your portfolio assets that are not correlated to each other. We want a correlation score as close to zero as possible. That’s the best way to reduce risk.

Here I’ve divided 2020 into before and after the SP500 market crash. I’ve plotted the daily return of BTC vs Gold vs SP500 and calculated the correlations for each pair on each period. Take a look at the chart.

BTC vs Gold Correlation:

  • Before the crash +0.17

  • After the crash +0.34

BTC vs SP500 Correlation:

  • Before the crash -0.18

  • After the crash +0.48

Gold vs SP500 Correlation:

  • Before the crash -0.43

  • After the crash +0.18

Yes BTC is getting more correlated to the SP500 after the crash. But the correlation coefficient for that period is still +0.48 which is not that high. 

It is too early to make any conclusion about that statistic. Is it a trend that’s there to stay? Is it related to Bitcoin’s volatility decline? I’m not sure.

So let’s wait for next Bitcoin breakout and see if that trend continues.


The not so invisible hand of the Fed

I’d hope that at this point everybody understands that Central Banks have messed up the free market. Ray Dalio was again talking about it in a recent interview on Bloomberg.

But it isn’t exactly a new thing. The Fed balance sheet is up 700% since the 2008 crisis. Liquidity is again flooding the market. Result: there is lots of cash chasing ever worst investment opportunities. 

And now what? Now the Fed is directly buying junk bonds. Next step is likely for the Fed to buy individual stocks…

You see where the problem is right? The Fed is not a normal market actor. They don’t care if the money is allocated to good businesses or not. 

This is not capitalism. This is messing up the free market. And it is about to get worst.

Just buy Bitcoin and opt out of the system.

Watch the interview.


People are mad about stock-to-flow

Well said:

I don’t really get why people are mad about PlanB stock-to-flow model

Nobody claims this model is the alpha and omega of understanding Bitcoin. And nobody claims that it is predicting the exact price that Bitcoin will trade at on any given day.

This model is helpful in understanding how scarcity is driving the valuation of Bitcoin over the halving cycles. Why is it important? Because scarcity is one of the core concepts of “BTC algorithmic monetary policy”.  

Let’s see how it plays out over this whole halving cycle before reaching any conclusion on its correctness. 

Whether or not it works in predicting Bitcoin’s price range based on scarcity there is definitely something useful to learn from it.


Selling puts

You know that investors are really desperate for yield when they turn to selling puts. This one is about Ethereum, not Bitcoin, but the same lesson applies.

What’s the idea? Say that ETH is at $240. In your misplaced overconfidence you are totally sure that in the next 30 days there is no way ETH will drop below $200 (famous last words). Then you sell puts on ETH at the $200 strike.

What happens then is that immediately upon selling you collect some pocket money which is the premium from selling the put.

At the same time you collect a liability. This liability says that if within 30 days Ethereum drops below $200 then the person who bought the put from you can sell his ETH for $200 whatever the actual price of ETH is. 

Being an insurance seller puts you on the hook for potential big losses when realized volatility spikes if you are not hedged. And if you hedged, well the yield you get from that ends up being very small…

Make sure you understand the risk/reward before entering this kind of trade.

Here is a cautionary tale of what can happen with this kind of strategy: https://www.bloomberg.com/news/articles/2018-11-21/founder-of-stricken-hedge-fund-promoted-selling-of-naked-options.

Recent data suggests this is happening at scale on ETH right now. Check out the article for more details.

Read the article.


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:

  1. Click on the subscribe button right below.

  2. Follow Ecoinometrics on Twitter at https://twitter.com/ecoinometrics

Done? That’s great! Thank you and enjoy.