Gold and Bitcoin Pop as Inflation Beast Stirs!

Precious metal prices have rallied this week, with both gold and silver up by close to 3% in USD terms, trading at USD $1354oz (gold), and USD $16.96oz (silver). In local currency terms, the yellow metal has again pushed back above AUD $1700oz, whilst silver is now trading at AUD $21.35oz.

The catalyst for the move was a US inflation print which came in higher than expected (more on this below). This figure came out on the same day we also saw a very soft retail sales figure, which came in at -0.3% for the month, with gold rallying , and the dollar weakening substantially in the aftermath.

The gains in the metals this week continue a solid run of performance for gold since the middle of December, with the precious metal market comfortably outperforming risk assets over that time period, especially during the recent uptick in market volatility.

From a technical perspective, gold is on relatively solid footing too, with the recent correction and consolidation around USD $1310oz representing another ‘higher low’ for the yellow metal.
The charts also look constructive, as you can see below, though until we’ve solidly moved through key levels around USD $1366oz, there is a chance these rallies will be sold.

Managed money longs had reduced their positions by over 10% in the week to February 6th, likely reflecting some profit taking into the recent corrective move in the metals.

Despite the solid moves in gold since late December, and the upgrade in forecasts from the likes of Goldman Sachs, there are still no shortage of naysayers. OCBC Bank have stated that they see gold in USD falling as low as USD $1,100oz by Q4 of 2018, with three headwinds; “the rosy economic outlook, tame inflationary backdrop and potentially higher interest rates”, (their words not mine), responsible for the fall.

If they are correct that growth continues to surprise to the upside, that inflation remains tame and the Fed does aggressively hike real rates, then no doubt gold will struggle, though there is no shortage of evidence to suggest growth may in fact disappoint vs. expectations, that inflation will (as it has this week) come in higher than expected, and that real rates may end up being lower than forecast, even if the Fed does hike nominal rates this year.

If that happens, then gold will remain the place to be, especially if the dollar continues to weaken and market volatility of the kind we’ve seen in the past fortnight persists.

On the inflation front at least, it looks like things are trending in favour of the yellow metal.

Inflation on the way back

Inflation figures from the USA were out this week, and showed an increase of 0.5% for the month of January alone, with the annual increase now coming in at 2.1% year on year.

The charts below, which come from ANZ, highlight developments in official inflation trends over the last few years. Not surprisingly, as per figure 1, official inflation figures bottomed out (at around 0%) in late 2015, early 2016, right around the time the gold price bottomed out.

Whilst hardly out of control, the sustained increase in inflationary pressures since is evident in the chart, with figure 4 also highlighting that core inflation is now tending higher too. Just as importantly, energy prices are now adding a significant contribution to higher rates of inflation, whilst tightness in the labour market is another factor.

Add it all together, and the inflation genie is starting to get out of the bottle, rattling the confidence of bond market investors, and sustaining some demand for precious metals, irrespective of the markets expectations that the Fed will hike interest rates.

Concern regarding the sustainability of the US budget position (which is again on track to record over USD $1 Trillion in deficits on an annual basis) is another factor, with their being almost no political on either side of politics to wind back a persistently profligate Washington.

This trend will likely take years to fully play out, but it increasingly looks like the colossal asset price inflation that we’ve seen since the “end” of the global financial prices is finally spilling over into consumer prices and the real economy.

For as long as that trends plays out, it's (on a relative basis at least) going to more supportive of real assets vs. financial assets.

Bitcoin Bounces but Fails Test

Bitcoin bulls have had a good week, with the price rallying back above USD $10,000 per coin. After the circa 70% crash from late December to early February, where prices fell from close to USD $20,000 to below USD $6,000 on some exchanges, this move higher is no doubt welcome relief, and can be seen on the chart below.

From our perspective, we’d expect to see the price face significant resistance around the USD $10,000 – USD $11,000 mark, and wouldn’t be surprised to see the market weaken again from here. The technical picture supports this view, though given the inherent volatility in Bitcoin, and in the crypto space more generally, we’ll have to wait and see how the price action plays out.

From a more general perspective, we were interested in a Business Insider article about Bitcoin, which looked at some research from two economists at the US Federal Reserve. The research highlighted a few concerns with Bitcoin, including the volatility of its price at present, and why that would act as a major barrier to it ever being a widely used currency, should said volatility persist.

Of more interest though was the subject of convenience, and how easy it is to use Bitcoin as a method of payment. According to the economists at the Fed, Bitcoin proponents who argue that Bitcoin will be a more efficient means of moving money around the economy are addressing a problem that doesn’t necessarily need to be solved. By that, they mean that the current system of moving money around the economy, whilst not without friction (i.e. there are costs and time delays involved) actually quite well.

That assertion is obviously completely at odds with the view of Bitcoin bulls, including the Winklevoss twins, who recently commented that: “if you want to get money from New York to London on a Friday night, go to JFK, jump on a plane with a bag of cash and you’ll get there quicker than when you actually wire.”

Their argument is that the banking system is still so archaic that it takes days to move money, even though in essence, a wire of money from Bank A in New York to bank B in London is just a series of entries into a database.

From our perspective, both arguments have some merit. The Winklevii are correct to say that the way in which money moves around our economy could be improved. The Fed economists are also correct to point out that whilst the current system is imperfect, it is hardly a major deficiency causing severe hardship or a major handbrake in terms of generating higher levels of economic prosperity.

Furthermore, we’d point out that the pipelines supporting the movement of money around the financial system are forever improving, something Australia itself has been witness to this week, with the much hyped launch of the New Payments Platform, which allows interbank transfers using a very simple ID system.

Bitcoin on the other hand is way too slow and expensive, something that it may never solve. Indeed one of its biggest proponents, Saifadeen Ammous, author of The Bitcoin Standard, has stated that; “In my opinion, there is no way that a decentralized network will be more efficient in processing transactions than a centralized network, because a centralized network needs one record of transactions and a few back-ups. A decentralized network has to record it over thousands and tens of thousands of computers. So we have to expend much more processing power, and we’ll need much more time to sync all of the ledgers together, as we see with bitcoin.”

In the same article that he made that comment, Ammous also stated that it can take 30-40 minutes for a Bitcoin transaction to process, and that the cost of that transaction is $2 to $3.

Imagine having to pay $6 for your morning coffee ($4 for the coffee and a $2 transaction cost), and wait 30-40 minutes for the Barista to hand it over because that’s how long it takes them to receive the money in their Bitcoin account.

Hardly appealing, isn't it?

Given this, I think we can safely say that the argument that Bitcoin is the future of money because it will prove more efficient to use in day-to-day commerce is dead in the water. Not only is the current system growing more efficient by the day, but Bitcoin is still exceptionally slow, and seems destined to remain that way.

In essence, this leaves one major argument that can be made to support Bitcoin as an investment, namely that due to its limited supply, it will prove a superior store of value over time.

This is stronger ground for crypto-enthusiasts to stand on, for the core issue with money today (as we see it) is not that it is too inefficient to use in daily commerce, or that it moves too slowly around the financial system. Instead, the core issue is that money today can be created out of nothing, indeed it is being created out of nothing, and this has created a large and growing imbalance between the amount of money, and the amount of goods and services that that money has a claim on.

Over time, this can’t help but create inflation, either of the consumer price, or financial asset kind, either of which end up creating no shortage of economic hardship for a significant portion of the population.

As to whether Bitcoin proves a long-term solution to these problems, of course remains to be seen, given it has only existed since 2009, a period that by and large has been characterised by record low volatility, record high asset prices, and some of the lowest levels of official inflation on record.

In short, it hasn’t really been tested, even as a defensive, uncorrelated asset, though what tests it has gone through (for example the recent sell off in equities and uptick in volatility), it has largely failed, given the extreme sell off we’ve seen since December, which has coincided with the circa 10% correction in listed equity markets.

Gold on the other hand has kept on keeping on, now trading above USD $1350oz, provided much needed balance to investor portfolios.

Combine this together and you have a scenario where Bitcoin is fundamentally uncompetitive as a pipeline for moving money around the economy, relative to the existing networks, and remains inferior gold as a defensive portfolio asset, with nowhere it’s track record as a store of value.

This is of course not to argue that the price couldn’t go a lot higher in another rally, but more pessimistic observers have a case when they argue why they think Bitcoin is going a lot lot lower over time.

You can read the Business Insider article mentioned here, as well as a much longer and genuinely fascinating article from the New York Times here, which looks at blockchain; “beyond the bitcoin bubble”.

Until next time,
Jordan Eliseo

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