There was an interesting quote that we picked up on this week from a Sohn Conference Foundation conversation between John Collison and Stanley Druckenmiller, where Druckenmiller said “if you believe that we are going to have irresponsible monetary policy and inflation going forward, if it’s in a bull phase, you want to own bitcoin, but if it’s in a bear phase, you want to own gold”. To us, that sentence perfectly encapsulates the relationship between the two assets. For an investor that doesn’t have a preference between the two and is just looking to invest in whichever is the most profitable in an inflationary environment, it is important to understand who actually trades in these markets. After all, assets move because of buyers, nothing else.
Bitcoin has a relatively high correlation with growth stocks and ETFs like ARK Innovation and the Nasdaq 100 to a lesser extent. It’s generally the younger demographic of investors that believe in bitcoin, and naturally the younger generation become more interested in the financial markets during strong bull markets – just look at the dotcom and covid bull runs for proof. Gold on the other hand, is often touted by older investors that are pessimistic about the future of the economy. The buyers of both assets are very different demographics but have relatively similar views of the future of the economy.
The thing about younger investors in a strong bull market like what we have had for the past 12 years, is that most of the time that is the only experience they have in the markets. The majority of these younger investors or generally those who invest in high P/E, high P/S type stocks get discouraged when they lose a lot of money from what they saw as an unexpected bear market. How many investors, retail traders, or even money managers are still playing the markets in 2022 after having huge drawdowns during the bursting of the dotcom bubble? Not many we can tell you that. Young, aggressive, growth stock investors of often believe that buying the dip always works, and that growth stocks will forever be in a magical bull market. Once they see large losses in their accounts as declines in spending, rising interest rates, or sector rotation begins, the majority become fed up with the markets and give up altogether as they become resentful and think the market is rigged or out to get them. Bitcoin doesn’t act as an inflation hedge in recessionary times because all the youthful exuberance is sucked out of the economy. In a recession, the only people left to play the inflationary trade are the veterans that have been through several business cycles in the past – these are the types of investors that buy gold over bitcoin.
In bitcoin’s current state it flourishes in situations where there are fears of high inflation combined with a lot of money sloshing around in financial markets. As bitcoin is often viewed as a risk-on asset by investors due to its young nature, buyers come in and push up the price. Contrarily, gold is viewed as a risk-off trade, or in general as a protection against the decline of other asset classes. In our view, bitcoin is procyclical and gold is countercyclical, it’s as simple as that. This may change in the coming decades if bitcoin matures and cements its place as a true financial asset, but until then this is how we will approach the inflation hedging argument.