Bitcoin and Gold: A match made in heaven
February 3, 2023
Desmond Foo and Coco Fang
Gold to Continue Shining
In a recent report, China increased its gold reserves for a second consecutive month in December last year by 30 tons, following an increase of 32 tons in November. This was its first reported gain since 2019, bringing total bullion reserves to 2,010 tons. According to the World Gold Council, central banks added nearly 400 tons of gold in 3Q22. This was a 300% gain y-y and comes in at the fastest pace since 1967 when the US dollar was still backed by bullion.
One driving factor for gold demand is its safe haven feature. In times of volatility and uncertainty, investors traditionally seek safety in the yellow metal which is seen as a store of value and not tied to any individual economy. In addition, a weakening US dollar outlook, together with countries’ willingness to be less dollar-dependent, have provided impetuses for foreign governments to swap their reserves from US Treasuries to gold. Gold also provides a possible way to sidestep Western sanctions on Russia, whose reserves have largely been frozen since March last year.
The Fed’s tightening monetary cycle is expected to be closer to its end than the beginning. Some analysts, perhaps prematurely, forecast the Fed to pivot during the third quarter of this year. Regardless, even a pause in rate hikes could be supportive of gold, as central banks turn less hawkish relative to 12 months ago amid decelerating inflation. Real yields, which have a strong negative correlation to gold, have also been weakening; the U.S.10-year real yield topped in November last year at 1.8% and has since declined to 1.2% this week. In addition, the latest CFTC data indicate that hedge fund managers have increased their bullish bets on gold for a seventh consecutive week to a 9-month high. ETF holders have yet to indicate a similar shift, with total gold held by ETFs falling by 0.3% so far this year despite rising gold prices. Should ETF holders start to pile in, we could witness more upside in gold prices.
In conclusion, the macro fundamental backdrop is supportive of gold and we believe it warrants exposure in one’s overall asset allocation.
Time to Turn Bullish on Crypto?
Cryptocurrencies have had an astonishing start to 2023. The rebound can largely be attributed to global interest rates peaking at lower levels, paving the way for more “risk-on” positioning by investors. For the last few years, bitcoin and the broader crypto ecosystem have been waiting for a significant fundamental push that may signal an end to crypto winter. This January, BlackRock contributed to such a push by adding bitcoin to its $15 billion Global Allocation Fund. This creates a catalyst for broader acceptance of the asset class and opens the door for other institutional investors to follow suit. Importantly, beyond a trading opportunity, cryptocurrencies may offer unique exposure characters that are of benefit to an ever-increasing investor pool.
First, cryptocurrencies offer hedging or diversification benefits. Prior to 2021, bitcoin demonstrated a low or slightly negative correlation to major asset classes, such as S&P 500, European stocks, and U.S. bonds. Though the correlation turned positive over the last 2 years, we believe it may well go back to prior behavior as the headwind of rising rates disappears. Second, crypto volatility is likely to continue to decline as the bitcoin market matures and more experienced investors establish positions in the long term. Two of the largest U.S. conventional commodities exchanges now offer bitcoin futures and regulated options for professional traders. Canada and Switzerland have permitted physical crypto ETFs for retail use. More and more traditional custodians offer cryptocurrency safekeeping and custody. Third, government policy seems to be turning the corner toward the support of this new asset class. New initiatives are likely to emerge, focused on transparency, custody, and protection of customers’ digital assets within the traditional financial system.
Given the long-term direction of travel and the easing of monetary tightening headwinds, we believe cryptocurrencies may well outperform substantially in 2023.
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Investments in commodities may have greater volatility than investments in traditional securities, particularly if the instruments involve leverage. The value of commodity-linked derivative instruments may be affected by changes in overall market movements, commodity index volatility, changes in interest rates or factors affecting a particular industry or commodity, such as drought, floods, weather, livestock disease, embargoes, tariffs and international economic, political and regulatory developments. Use of leveraged commodity-linked derivatives creates an opportunity for increased return but, at the same time, creates the possibility for greater loss.
Diversification does not guarantee a profit or protect against a loss in a declining market. It is a method used to help manage investment risk.
Cryptocurrency is a digital representation of value that functions as a medium of exchange, a unit of account, or a store of value, but it does not have legal tender status. Cryptocurrencies are sometimes exchanged for U.S. dollars or other currencies around the world, but they are not generally backed or supported by any government or central bank. Their value is completely derived by market forces of supply and demand, and they are more volatile than traditional currencies. Cryptocurrencies are not covered by either FDIC or SIPC insurance. Legislative and regulatory changes or actions at the state, federal, or international level may adversely affect the use, transfer, exchange, and value of cryptocurrency.
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