Bitcoin Versus Gold: Winners Of Failing Fiat Currencies

While in recent weeks gold slowly dropped in value, Bitcoin rose a stunning seventy-five percent since late September. Both asset classes have thrived on increasing central bank interventions, boosting safe-haven assets. Which one will prevail: physical gold or blockchain-protected Bitcoin?

The story of Bitcoin is known, the blockchain technology has made it one of the best performing financial assets of the previous decade. Blockchain-build technological advancements have much future growth potential. The rise of FinTech is a symptom of increasing competition of blockchain technologies, which goes further than basic cryptocurrencies that provide protection against unconventional central bank policies.

Large Gold Purchases Have Not Prevented The Depreciation Of Currencies

Last year central banks bought more bullion than anytime since 1971, when the U.S. ended the gold standard, according to Bloomberg.¹ This year, the Turkish and Russian central banks have faced large depreciation of their currencies. However, in Q3 2020 Turkey decided to sell gold for the first time in years, as their currency depreciated despite their excessive and aggressive purchasing of gold in recent years. Back in 2017 the Turkish government legislated a law that enables the Turkish government and central bank the right to be able to buy-up all the mined gold output of the nation. This is exactly what they have done in recent years, their gold reserves are seven times as high as in 2011, but investors don’t see it as a guarantee to a stable currency. Holding gold or foreign exchange reserves can be effective in stable times, but when the entire market opposes a currency, even the wealthiest central bank can often do nothing.

Hiking Interest Rates Is The Only Effective Measure To Inflation

After months of depreciation President Erdogan announced the central bank would hike interest rates to over 15 percent to fight the rising inflation within the nation. The weakening currency has caused “imported inflation” to creep into Turkey. The corona crisis has led financial speculators to significantly depreciate the Turkish Lira. Imports therefore get more expensive, the only thing entrepreneurs can do is increase their prices and therefore this speculative attack has become a self-fulfilling prophecy. At first sight the announcement of the hiked central bank interest rate has appreciated the Turkish lira for now. However, it actually could well be that the vaccine-boosted positive prospects also reduced depreciative speculation.

The price dynamics of gold are extremely complex as there are different industries that create demand. In Q3 weakened central bank demand, lower consumer demand through jewelry and a safe-haven outflow after positive vaccine news has caused gold prices to consolidate to a level of around $1875 dollar. While gold prices may fall more on the short term, it should be noted that consumer jewelry demand out of India, which has dropped 20 percent year-to-date, could pick up when the economy recovers. Jewelry demand in India is very important for the gold price and could offset lower central bank demand in 2021. Moreover, it should be noted that since interest rates are negative or close to zero, investment demand should not change much now safe-haven outflow of short term investors should be over. Before the end of the year we can expect new fiscal stimulus in the United States and a new ECB stimulus package which could potentially drive gold prices higher.

Figure 1 -Distribution Of Gold Demand By Industry

The unconventional quantitative easing measures by the central banks could cause inflation in the corona aftermath. However, as the ECB and the Federal Reserve cannot let interest rates rise due to the increasing amount of companies dependent on the low-interest rate environment. This creates the ultimate scenario for gold, a situation where central banks have their hands tight to fight inflation. Increasing interest rates would mean hurting the economy and causing a debt bubble to pop, which can only be prevented by more quantitative easing. A disastrous economic scenario for the global economy, but an extremely bullish scenario for gold prices.

The Role Bitcoin Could Play And The Likely Pitfall

Bitcoin has much potential as the major cryptocurrency, with an estimated dominance of more than 67 percent of all the market capitalization of cryptocurrencies, however the main competitor for gold faces a potential harmful scenario. While gold price dynamics are well-balanced through demand out of different industries, Bitcoin has only demand out of the investment industry. This does not mean that the role for Bitcoin is limited, however it should be noted that this causes higher fluctuations for the cryptocurrency. These fluctuations make it less effective as a store of value, even though consumer demand out of Turkey has risen. Turkish people are used to fluctuations in value and have seen large devaluations of their cash holdings over the years, which makes it a fruitful ground for Bitcoin to rise as a store of value.

If the disastrous scenario which The Golden Investor has discussed above becomes reality, then Bitcoin could potentially be the ultimate asset class for non-investment consumer demand. Where initially central banks were weary of introducing digital currencies, now the ECB is looking to introduce an fully digital currency to remain in control of capital flows. However, this would be counterproductive as consumers would run even harder to different stores of values if their financial freedom becomes limited. Then again, it is highly unknown what a reasonable price for Bitcoin is, because it is impossible to calculate as it is merely an investment vehicle. Slowly, it becomes more and more possible to pay and use Bitcoin in the real digital economy. The digital payment company Square recently announced it would buy 50 million dollars of Bitcoin to diversify their cash position. Also PayPal and Just Eat Takeaway recently announced it would be possible to hold Bitcoin and pay with it. These are the first signs that Bitcoin could really thrive as a digital currency. Their current market capitalization stands at 330 billion dollars, in a 160 trillion dollar global economy there is still much more room for growth.

However, it should be noted that the anonymity of cryptocurrencies are slightly exaggerated, for ordinary people it is hard to buy Bitcoin without requiring to identify. Also it should be noted that governments are against cryptocurrencies, the lack of control makes it a source of suspicion and for real introduction of Bitcoin into the real world acceptation of all parties is necessary. Therefore, The Golden Investor remains cautious on real implementation of cryptocurrencies within the real economy. In an era of extremely unconventional central bank policies, it is for governments extremely important that their practices don’t become undermined and harmed by speculative cryptocurrencies. Counterattacks to cryptocurrencies by governments could severely harm the value of Bitcoin and other cryptocurrencies.

The increasing debt burden probably will be payed by workers through higher tax rates, which will hurt jewelry demand for gold. Silver has relatively much more industrial demand, which means that when the economy reopens, silver has more room for growth as safe-haven. It would be advisable to have some exposure to the three different safe-haven classes to lower the beta of your portfolio, especially since the corona financial crisis just started. However, the focus of investors should not be on pessimistic central bank views. The most gains can be made with real change, innovation and shifting paradigms. Safe-havens assets can be profitable, especially in uncertain times, however the most profitable investments are related to positive changes in our quality of life.

Disclaimer: The Golden Investor is not a fortune-teller, be sure to make the right decisions in accordance to your own financial situation, this is not investment advise or anything like that.



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