The rise of cryptocurrencies and digital assets over the past few years has given rise to a whole new class of traders, those with seemingly little investing experience. They are certainly not from the standard capital markets theory classes that a fund manager goes through when starting to manage money. But with returns close to 1,000% or more, the investments of these new traders understandably got the limelight, and there has been a secular shift in the way we view digital assets.
But that does not mean one can forget risk management altogether. As more and more institutions rack up their bitcoin holdings, it also means the correlation of bitcoin to most traditional assets starts going up, especially during times of broader asset unwinding and derisking. What was once an ultimate uncorrelated asset starts behaving like the rest. The "new" digital traders can ignore equities, bonds, or macro, but this is going to be more and more important; cross asset correlation.
There is no doubt a fundamental theme of going long an asset that halves every four years with supply only getting less and less, while demand is rising post institution and government take up. But what is the real fair value price of bitcoin, is it really $100,000 or $500,000, do we really know? The ardent stock-to-flow die hard believers of bitcoin claim it can go to a million dollars. After it hit its highs of $65,000 in April, it has since then fallen about 35%. It did fall all the way down to $29,000, but has since bounced back up to its old $40,000 level. There is no doubt that the charts are looking precarious, as the short- and medium-term trend is broken. About 80% or more of holdings are kept with institutions, which are not really changing their holdings, so about 20% is still susceptible to retail hysteria and hype. But we have seen three other cycles of bitcoin 2013, 2017, and perhaps this one, where there have been huge booms and busts.
Will this time be similar to 2017?
We all know how global central banks have printed money ad nauseam and debt to GDP has been a one-way trend. Never reducing or tapering asset purchases in the good times means that when we face another hiccup, central banks will need to provide more stimulus, and print again. There is just one way for the dollar and fiat currencies as we know it. But that does not mean we cannot get mini booms and busts. Every asset class over the past year, and past decade, has benefited from the massive liquidity surge in the market.
Whether we like to believe it or not, it is all one big macro trade as some assets may just be a smaller multiple exposure to the same grander theme. Over the past few months, cyclicals have lost most of their momentum from the first half of this year, as market is worried about global growth plateauing at a time when inflation is extremely high and resilient: stagflation. The Fed has a dual objective, full employment and 2% average inflation. It has certainly achieved the latter, but the former seems to be lagging. The time is getting closer and closer for the Fed to start tapering assets as inflation might spiral out of control.
The Fed is in a catch-22 situation. If it prints more, it risks even higher inflation. If it does not, then all asset classes can crumble without support. China has been in deleveraging mode since November of last year, and when China sneezes, the world catches a cold. This has finally hit asset markets around the world, especially reflation cyclical assets. As Chinese property developers are falling 50%-80% or more, on back of a potential Evergrande default, screams of a China hard landing are being echoing everywhere. Everyone seems to have become a property expert now.
It remains to be seen what China does. But one thing is for sure, they are extremely tactical and will not let one company hurt 40% of their consumer's exposure, it is all about the people right now. Liquidity is the most important thing here. All eyes are on the Fed, as if it pulls the rug, then bitcoin, along with all secularly strong assets will get hit as well. Perhaps the China debacle has given them some breathing room, because we know how much the Fed needs any excuse to "not" taper.
