Ecoinometrics - Taking the long term view
May 31, 2021
Waiting for Bitcoin to get out of this drawdown is like watching paint dry. So while the price action is whatever it is on a daily basis, it is again time to take the long term view.
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:
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Goldman on crypto
Goldman Sachs just released a report examining crypto as an emerging asset class.
You can check it out here.
Often banks coverage of the crypto space is quite poor. But I must say that this research from Goldman does a pretty good job at giving a diverse high level picture of what’s going on.
Not that I agree with everything in it but honestly I was expecting much worst.
The report is 41 pages long so we are not going to discuss everything. There are a few points I want to address though.
Here is a quote that you can find in the executive summary of the report:
“Christian Mueller-Glissmann, GS Senior Multi-Asset Strategist, then makes the case that for an asset to add value to a portfolio, it has to offer either an attractive risk/reward or low correlations with other macro assets, and preferably both. He finds that a small allocation to bitcoin in a standard US 60/40 portfolio since 2014 would’ve led to strong outperformance, owing both to higher risk-adjusted returns for bitcoin compared to the S&P 500 and US 10y bonds, as well as diversification benefits from relatively low correlations between bitcoin and other assets. But with this outperformance largely owing to only a handful of idiosyncratic bitcoin rallies, he concludes that bitcoin’s short and volatile history makes it too soon to conclude how much value it adds to a balanced portfolio.”
Yes, Bitcoin has only a short history when compared to gold, the stock market as a whole or the bonds market.
Yes, the longer you wait to invest, the more data you will have and the more certain you will be about Bitcoin’s historical properties.
But the problem is that if you wait too long you risk missing on a lot of upside during the adoption phase. This is what is referred above as those “idiosyncratic Bitcoin rallies”.
So I guess it depends on what you want out of Bitcoin.
If you think that Bitcoin offers a good risk adjusted investment opportunity but you are uncertain about it then start by taking a smaller position. As your conviction grows it is always time to start adding more but at least you wouldn’t miss entirely on asymmetric returns.
The analysis by Christian Mueller-Glissmann shows that a single digit allocation to Bitcoin does improve the risk adjusted returns of a 60/40 portfolio. If you allocate say 5% of your portfolio to BTC what can happen?
Maybe Bitcoin will go up 10x in the next 5 years and give a big boost to your returns.
Maybe Bitcoin performs as an uncorrelated asset to bonds and the stock market even if the performance isn’t massive.
Maybe Bitcoin goes to zero and you lose 5% of your portfolio.
The small risk is worth the potential reward.
We have discussed that several times in the past. You can go check it out here and here.
Nouriel Roubini is interviewed for the report and as usual he is repeating the same thing. At least the guy is consistent. You’ve probably heard it already but the idea is that Bitcoin has no value because it has no use in the physical world and does not produce any income.
That kind of view doesn’t fit reality very well when you consider that BTC has suffered numerous booms and busts but is still alive and growing despite all that. Not really what you expect from something that has no value.
I found that Zach Pandl’s view on Bitcoin’s valuation is a much better way of thinking about it. At least a view that’s much closer to how the asset is actually priced.
The market in aggregate has developed a view that Bitcoin is suitable as a store of value. That is the dominant narrative of Bitcoin as digital gold and that’s its utility.
Given the finite nature of BTC you can put a price tag on that. Basically anywhere between one BTC being worth $130k (gold in financial instruments) and $500k (total physical gold market) at the current value of the US dollar.
But while Bitcoin is suitable as a global store of value, it isn’t guaranteed to reach this status. There are hurdles along the way that the market is pricing in on a daily basis.
When the market sees the probability of reaching the end game rising the price follows. When the market sees the probability of achieving the final state decrease the price drops.
So if you are looking far away into the future there is a clear path for Bitcoin to continue climbing on the adoption curve as the uncertainties dissipate.
All in all we are still early. If you keep a long time horizon and disregard short term volatility Bitcoin remains a great opportunity.
Inflation is here…
… but the bond market does not seem to care. I mean look at this. The latest CPI inflation print rose to a 10-year high.
But when you look at the US 10-year yield there was basically no reaction. It is pinned around 1.60%.
And actually if you look at the yield curve as a whole not much as change in the past couple of months. The front end of the curve is pinned at 0% by the Federal Reserve while the back of the curve is basically at the pre-pandemic level.
This has been cited as a reason for simply ignoring inflation as just a consequence of a re-opening of the economy after COVID. Something very transitory. An anomaly in the data.
After all, the bond market is a game for the smart money, people who supposedly really know what they are doing. So if the smart money isn’t worried, why should you be?
I think the situation is a bit more complicated than that.
Right now the CPI inflation looks high because of the base effect. March, April and May last year is when the US economy got hit hard by the COVID lockdown. The result is that the CPI dropped around this time a year ago. And that is creating a low base which is now used to calculate year-on-year inflation.
That means it is hard to know if the inflation print is just a result of the base effect or if there is something bigger. Until we are out of the base effect zone in a couple of months there is still plausible deniability: “we swear there is no real inflation, it is all the base effect”.
So what should you do? Wait or take action right now?
There is a proverb that says:
“Don’t wait to be thirsty to start digging a well.”
As Dan Held pointed out in its recent coverage of inflation there is a substantial risk that the Fed will mess up this one and get itself in a situation where inflation could be out of control.
So my opinion is, don’t wait until it is too late to start hedging against it. Act now.
That’s it for today. If you have learned something please subscribe and share to help the newsletter grow.
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.
Done? That’s great!
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Great read as ever, thank you