This is not a write-up on individual stocks, but with all the buzz going on, I'd like to share my personal view on cryptocurrencies and precious metal for those who are interested. Disclaimer: I own both in my portfolio.
Many like to criticize crypto and precious metals because they are not income producing assets. Here is my question: why do people buy bonds? Because bond holders earn interest income by lending money to others. However, many don't know that the earned interest is denoted in fiat currencies, not the real purchasing power. The increased account balance in your bank may well be delusional to make you feel you have more money to buy more goods and services.
For example, you love eating apples and one apple costs you $1 today. You have $100 cash which can be converted into 100 apples. Now you decide to invest instead and use all your cash to purchase a bond of $100 with an interest rate of 10%. The next year you are paid the interest $10, and you thought you have $110 cash to buy apples. However, what if I tell you one apple has become more expensive and will cost you $2 now? Congratulations, you earned interest, but your money can buy you only 55 apples. This is so-called inflation.
The example above is extreme because we don’t have 100% inflation rate in any developed nations, but if you understand the logic, you will see this is exactly what is happening in most developed nations due to all the loose monetary policy and money printing, including the US, EU and Japan - the real interest rate is negative. Real interest rate = nominal interest rate - inflation rate. When the inflation is higher than the nominal interest rate, holding bond with negative real interest rate over time will actually decrease your purchasing power. I'm not making this up. This is today's real interest rate published by U.S. Department of the Treasury - the real interest rate is sitting negative for US government bonds with all maturities. Inflation is the fiat currency depreciating against all other goods and services.
In the old barter economy where people directly exchange goods and services for other goods and services, how much you can exchange for apples with other goods depends on the demand and supply of both products. For example, you have 1 gram of gold that is worth $100. Assume both apples and gold have constant demand and supply over time. 1 gram of gold can exchange for 100 apples ($1 per apple) today; next year when the price of apple increases to $2, the 1 gram of gold you have will also increase to $200 (think the fiat currency is just a unit of account), and can still exchange for 100 apples. Regardless of the fiat currency movement, the purchasing power remains the same.
You can consider precious metal and cryptocurrency as a special bond with zero real interest rate that retains your purchasing power. They can perfectly hedge the inflation risk, but that has one condition - the demand and supply for them is relatively stable compared to other goods and services. If a new technology is invented to increase the production of apples at lower cost, given all the other conditions the same, 1 gram of gold can actually buy you more than 100 apples now because the supply of apples has increased.
Let’s examine the supply and demand of precious metal and cryptocurrencies. Supply is easy. Gold discovery and mining is relatively stable (gold production may have peaked steady). Unless people invent a technology to extract gold from sea water in a cheap way, I don't expect much surge in gold supply. Cryptocurrencies are more straightforward. One of the things that supporters like to tout about crypto is the capped supply of Bitcoin. Bitcoin's supply is strictly limited to 21 million coins. After halving of Bitcoin this year, the new supply will become half of the prior amount.
Switching to the demand side which is trickier. The demand for something is not necessarily based on the usability of a certain product. Besides decoration and jewelries, gold doesn't have much industry application, but people like its rarity and stability so the value of gold has been persisting over thousands of years throughout our human history. It is the consensus among the crowd that creates demand and assigns a price to a product. The value of gold will not change much if just a few people think gold is absolutely useless and decide never to own any gold. It really doesn't matter what YOU think about gold. When the majority of the population start to like, want and desire gold, the demand will be developed. Once the demand hits a critical mass, even the early doubters will be forced into adopters because they have no other choice but to own some gold when overwhelmingly majority has accepted it. It's just crowd psychology.
Similarly, many crypto bears often argue that cryptos are useless, inconvenient, waste of energy, etc. Keep in mind that the demand of a product is not determined by its usability. It is people's perception that creates the demand and value. Just like precious metals, cryptocurrencies are also stable and have limited supplies. Think about it - over the past few years, do more or less people hear about cryptocurrencies? Do more or less people accept it as an asset or payment? Just look at the adoption of crypto by institutions and the growing inflows into GBTC; the answers are clear to me. Thanks to the bears, they also played a very important role to increase the awareness among the crowd. Ask people around and see how many actually own cryptocurrencies - I believe we are still in a very early stage of adoption but it's important to know where the trend is going. However, not all the cryptocurrencies are created the same - I would stick with the ones on the top of the list which are most recognized and accepted. Again, it is how other people think that matters the most to determine the demand. Just follow the trend.
Not many people realize the safe government bonds they hold are producing negative real interest rate for them. These investors may see an increase in their bank balance with the earned interest, but by the time when they need to convert their bonds into real goods and services, they will realize their purchasing power has become less by holding the bond. Now, if I present you with i) a bond with a negative real interest rate and ii) an asset that has zero real interest rate, what would you pick?
This is why I believe the potential demand for precious metal and cryptocurrencies is far from fully realized. When the majority starts to understand the logic above, animal spirit will drive the crowd into precious metal and cryptocurrencies, increasing the demand and price of the asset. The increased price will attract even more buyers to follow, pushing up the demand even higher. At that time, precious metals and/or cryptocurrencies may well become another bubble. That's when I will sell, but right now it's far from there.
The Bitcoin price chart is a bonus for those curious technical chartists. I'm not saying right now it's a low risk point to buy BTC, but look at the big volume bars when the price was at the bottom since 2019. It is obvious to me that some big players are accumulating. In contrast, the volume during the distribution phase was really nothing comparable when the price hit the top in 2017. The on-going upward trend has been confirmed by an increasing volume along with it. If the 2017 "bubble" is mostly created by retail investors, the run-up this time will be driven by institutions. It will go much higher from here. I will hold until the smart money distributes.
Footnote: in my opinion, cryptocurrency is never going to be a replacement to our current currency system exactly due to its limited supply. When the economy grows and GDP increases over time, ideally, we need the equivalent increase in money supply (maybe slightly more) to denote the additional productivity. Money is important to facilitate transactions in an economy. When there is not enough money in circulation, deflation will happen where goods and services become cheaper compared to the currency. When deflation happens, people would rather hold cash and not spend it because they expect the goods and services to become cheaper in the future. When people are reluctant to spend and make transactions, the economy will shrink and collapse.
Before industrial revolution, our global economies are pretty stagnant without much growth up until 20th century. Gold/silver standard had worked well because the supply of gold and silver are relatively stable too. However, the supply of gold or silver becomes insufficient to support the exponential growth of economies after 20th century, and that's why we see all countries have abandoned gold or silver standard. This is the same reason why Bitcoin can never replace our current currency system.
