Want to embarrass a Wall Street stock analyst? Ask them about the meteoric rise of the price of bitcoin (CCC:BTC). How can bitcoin, an asset with seemly zero underlying value, be worth more than any of America’s largest banks?
Cryptocurrency investors have had little time for such trifles. Instead, they’ve been busy making money — or paper profits, at least. Since December, BTC price has shot from $20,000 to nearly $36,000 with the vigor of a rabid racehorse. My article predicting $30,000 in 2021 became outdated in less than a week. Now, with Bitcoin hitting daily records, many traditional investors are asking themselves, “Is it too late to jump in?”
In short: It’s not too late … if you’re willing to speculate. Bitcoin is a surprisingly “risk-on” asset that goes up when confidence is high. And with few roadblocks in the way of economic recovery, Bitcoin’s run looks set to continue, at least in the near term. But when times get tough, don’t expect BTC to protect you either.
Bitcoin prices look strong in the near term.
There are few roadblocks to a further rise.
Investors need to balance BTC with countercyclical investments.
BTC: A Risk-On Asset
Longtime readers of mine will know that the comparison between bitcoin and gold is utter nonsense. Gold is a traditional “safe-haven” asset that tends to hold its value when times get tough. On the other hand, bitcoin is a “risk-on” asset, much like stocks, junk bonds and fine whiskeys. When times are good, these assets go up in price. But when the economy sneezes, these investments are first in line to catch pneumonia.
The data backs this up. Since 2015, bitcoin has seen a 20% correlation with junk bonds in their 30-day returns. With the S&P 500 stock index, it’s even higher: Investors can credit almost a third of bitcoin’s movement to the stock market. That’s great for investors during good times. Since 2015, bitcoin has risen 11 times faster than the stock market during bull markets. But the reverse is also true in downturns.
Don’t Stand in the Way of a Good Story
In the medium term, bitcoin looks set to continue its winning streak. Despite failed attempts to enact a larger stimulus, the U.S. government still managed to deliver a $900 billion stimulus in December. More could be on the way. And the unprecedented stimulus has economists rubbing their hands in glee; in December, Morgan Stanley upped its 2021 U.S. GDP (gross domestic product) estimates to more than 6%, a rate not seen since 1984. (The U.S. stock market would go on to notch up for five consecutive years.)
Bitcoin has also nabbed its own set of wins. In October, PayPal (NASDAQ:PYPL) announced it would accept bitcoin, joining Square (NYSE:SQ) in bringing cryptocurrency to mass market. Earlier this month, pro-football player Russell Okung announced he would receive half his paycheck in Bitcoin through a third-party app.
And in unrelated news, on Dec. 22, the SEC (Securities and Exchange Commission) announced charges against rival Ripple Labs, the administrator of altcoin XRP (CCC:XRP). With one of Bitcoin’s largest rivals now in question, the future looks even brighter for the lead dog.
A Balancing Act
Bitcoin investors, however, should temper their expectations. All good investing involves risk management, and buying Bitcoin means padding your portfolio with countercyclical stocks and other safe-haven investments. That’s because Bitcoin is NOT a currency or a safe-haven asset. When was the last time you used bitcoin to order pizza?
Instead, people invest in bitcoin because they believe one truth: that BTC will go up in price. That makes the cryptocurrency much more like a speculative asset, which means you should treat bitcoin much like buying S&P call options or a 1933 Double Eagle gold coin. For every dollar spent on bitcoin, at least as much should go toward portfolio protection.
And just like Wall Street’s dizzying menu of financial products, there’s no shortage of stocks or investments that have a low or negative correlation to Bitcoin.
Utilities: Dull for decades, electric utilities have emerged as a winner for solar investments. Correlation is only two-thirds of the S&P 500.
Treasury Bonds: The aptly named SHY index has a negative -20% correlation with Bitcoin.
Gold: Ironically, the ultimate bitcoin competitor only has a 1% correlation to the cryptocurrency.
The list goes on. But the popularity of “safe-haven” assets tell us one thing: Good times never last forever.
What Goes Up…
Bitcoin investors have always faced a bumpy road. In 2017, Bitcoin lost 84% of its value as institutional investors started cashing out. In the wild west of novel investments, bold investors will lose just as often as they win. And today’s price rise makes the 2018 “bubble” seem tame in comparison: BTC price now sits about 60% higher than its old peak. With bitcoin now available on Robinhood and other mobile apps, cryptocurrency trading looks more like a casino than a fungible currency.
Still, if you’re willing to hitch your portfolio to a glass cannon, bitcoin will provide the excitement. Good times are still here. The commonly tracked “fear gauge” — the spread between junk and investment-grade bonds — is still declining. Another several months of complacency could easily see bitcoin reaching $40,000 or more.
But when the tide turns, make sure you’re the first out the door. Any missed GDP estimate, political roadblock or Covid-19 mutation could send cryptocurrency into a tailspin. And without a meaningful underlying value, bitcoin could have far to fall. Speculators, get ready. It’s going to be yet another wild ride.
On the date of publication, Tom Yeung did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Tom Yeung, CFA, is a registered investment advisor on a mission to bring simplicity to the world of investing.