An increasing number of investors believe that cryptocurrency bitcoin has become an institutional-grade asset class – I agree. Some even believe that bitcoin replaces gold’s function in a portfolio. But with that, I disagree. Here’s why I believe that investors should own both – particularly in an inflationary environment.
Bitcoin’s recent strength reflects an exciting new digital financial world which isn’t going away. By owning bitcoin, you are exposed to that growth, and own a digital “hard” asset. With ever-fewer bitcoins being created in the future (see the box below), bitcoin will become increasingly scarce. By the year 2032, a high bitcoin price will be nearly 90% cheaper to sustain than it would be today. The miners (the supercomputers that solve the very hard sums that both create new bitcoins and allow transactions to be processed and logged on the blockchain) are paid to support and maintain the network, but will receive ever fewer bitcoins over time, with the resulting “inflation” rate approaching zero within a decade.
Where bitcoin and gold differ
The new supply of gold is also on a downward slope. This commonality between the two assets has gained much attention. Both gold and bitcoin are deemed to protect investors from inflation, which is one reason why some investors see them as interchangeable – or bitcoin as “gold 2.0”. But this is where they’re wrong.
The main difference between the two is that bitcoin thrives during “risk-on” conditions, whereas gold prefers “risk-off”. Risk-on occurs when the economy is growing, bond yields are rising (and so bond prices are falling), and animal spirits are in the air. In contrast, gold thrives when real interest rates (that is, bond yields minus inflation expectations) are declining. In other words, when inflation is rising yet bond yields are rising more quickly – which is what we’ve seen recently – that puts downward pressure on the gold price. By contrast, if inflation is rising more quickly than bond yields, you should expect gold to outperform bitcoin. In short, these two assets are not in competition – they are inherently different.
To see this in action, think back to the market panic in March 2020. When measured in pounds sterling, the gold price didn’t budge, whereas bitcoin’s price halved. A few months later, gold was all the rage as inflation expectations recovered while there remained doubts about the state of the economy, and thus bond yields remained low amid investor and central bank caution. This all came to an abrupt end when bond yields started to rise in August. That was the moment that the economy started to recover, and gold handed the baton to bitcoin. It was a macroeconomic shift. The next time the economy turns down, expect bitcoin to hand the baton back to gold.
So bitcoin is not replacing gold, and neither is it in competition – instead they serve completely different purposes. Both are inflation-sensitive…