In August, gold and Bitcoin were doing something unusual. Both were rising in value at the same time.
Typically, the two asset classes behave in different ways. Gold is the ultimate safe haven. It climbs when investors are fearful. When they are feeling greedy, Bitcoin is often the beneficiary, as bullish investors pile in.
So for the two to rise in lockstep is rare. Yet they appear to be telling investors the same thing: something is wrong with money.
In the US, government debt has passed $40 trillion, inflation is rising and investors have been worried about the outlook for the US dollar.
Many have been looking to protect their wealth by shifting it into assets that governments cannot print at will, reducing its value.
Andreas Anthis, head of multi-asset and absolute return at Mashreq Capital, says that when confidence in the purchasing power of a currency erodes, scarce assets are repriced upwards. “The supply of gold expands only at the pace of mine production, while Bitcoin’s supply is limited by design.”
Both started attracting money as investors worried about inflation, government debt and the long-term value of conventional currencies. The gold price climbed above $4,600, while Bitcoin topped $80,000 for the first time since May.
Now the US dollar is fighting back. What’s going on?
As the Middle East conflict drags on, the oil price is rising again, and that is likely to drive up inflation. That could force the US Federal Reserve to keep interest rates higher for longer, or even raise them. In that scenario, dollar-denominated assets become more attractive to investors.
The dollar has strengthened as a result, while gold has slipped towards $4,300. Bitcoin has fallen below $77,000.
Tony Hallside, chief executive of STP Partners in Dubai, says gold and Bitcoin’s simultaneous rise was no coincidence. “Investors were using different assets to express their concern about purchasing power of money and sustainability of government finances.”
Dollar debasement trade
This is part of something known as the “dollar debasement trade”, where nervous investors sell dollars and US government bonds to buy hard assets such as gold and Bitcoin.
But Mr Hallside says investors should not treat gold and Bitcoin the same. “Gold has centuries of history as a store of value and attracts significant demand from central banks. Bitcoin has inbuilt scarcity but remains much more volatile. It behaves like a risk asset during periods of genuine market stress.”
Ignore those who call Bitcoin “digital gold”, he adds. “It has some gold-like characteristics but hasn’t yet demonstrated its defensive qualities consistently across market cycles.”
This may be a good thing for private investors, Mr Hallside adds. As they behave in different ways, the two can coexist nicely in a diversified portfolio.
Today, gold and Bitcoin are in retreat. The debasement trade has just reversed and the dollar is fighting back.
With interest rates likely to rise, investors are remembering that gold and Bitcoin share the same downside: no interest, no dividends, no yield.
That is not such a bother when rates are low, but it is a problem when investors can get 5 per cent or 6 per cent from cash and bonds without risking as much of their capital.
Fawad Razaqzada, market analyst, global macro at Forex.com, says fears of a more hawkish Fed are hitting investors’ appetite for risk. “Global stocks, gold and Bitcoin are all falling as a result.”
The US dollar is now the safe haven trade. Good news for those earning in dollar-pegged currencies.
Recent talk of a dollar collapse was overdone, and not for the first time. Madhur Kakkar, chief executive of Elevate Financial Services, says the dollar erosion argument may be real, but the process will take decades. “Investors positioned for a dollar collapse have been wrong for a decade.” The dollar has been challenged before, and it survived.
Vaibhav Loomba, group head of FX and rates at Klay Group, says that after the euro was launched in 1999, the dollar suffered a massive cyclical downturn, losing 40 per cent of its value over the next decade. Yet it has retained its position as the world’s reserve currency. “The debate about the US dollar losing its magic has popped its head [up] many times over.”
The dollar faces short-term challenges over US debt and the country’s unpredictable trade policy, Mr Loomba says.
But it retains powerful structural advantages, including the size of the US economy, its powerful technology sector and the country’s key role in global trade. “The US also remains one of the higher interest rate countries in the developed world, thus helping the dollar from a carry trade perspective,” he says.
Exposure to dollar
Investors face another risk, though. Their exposure to the US dollar often comes bundled with heavy exposure to US shares.
Thanks to the performance of a small group of mega-cap technology companies, US equities now account for roughly 60 per cent of global market capitalisation, says Hamza Dweik, head of trading (Mena) at Saxo Bank. “When a handful of stocks account for such a large share of index returns, concentration risk naturally rises.”
Mr Dweik says there is a gradual reassessment of US exceptionalism, with America’s fiscal deficit, growing debt burden, trade frictions and political uncertainty encouraging investors to diversify away from US assets.
He anticipates a slow reduction in its share of global portfolios as central banks diversify reserves, trade settlement becomes multipolar, and investors allocate capital outside the US. “The dollar remains dominant, but its dominance is no longer being taken for granted.”
Darren Clarke, trader at Lunaro Financial Services, says investors must avoid excessive dependence on the US market. “The performance of US equities, particularly the Magnificent Seven tech mega-caps, has left many portfolios heavily pointed towards US assets, without investors consciously choosing to do this.”
That makes a broader portfolio increasingly attractive, with European, Japanese, emerging market and even UK dividend-paying companies offering ways to spread the risk, Mr Clarke adds.
The same applies to gold and Bitcoin. Instead of chasing them upwards, investors should be aiming for balance.
Mr Anthis at Mashreq Capital believes gold and Bitcoin can both have a place in a diversified portfolio, but neither is without risk. “Bitcoin, in particular, remains susceptible to sharp reversals.”
Lately, gold and Bitcoin have been moving in tandem, but over longer horizons, their behaviour tends to diverge, Mr Anthis says. “Over the past 12 months, gold advanced substantially while Bitcoin declined. Holding both is therefore complementary rather than duplicative.”
As always, investors should be wary of chasing assets upwards. As we have just seen, they can reverse course just as quickly.
Some investors might wish to take advantage of the recent gold and Bitcoin dip to increase their allocation at a reduced price.
The dollar may be rising today, but so is that $40 trillion debt pile. The debasement trade is not dead. Gold and Bitcoin may soon be rising again. And who knows, maybe even in lockstep.
