Gold or bitcoin? What’s the best buffer against inflation in 2021?
By Jenal Mehta
Edited by Anil Varma
14:00, 23 November 2021
As 2021 enters its last lap, the investment world is up against a clear and present danger it hasn’t encountered in decades – inflation.
And those seeking protection from this age-old menace are now faced with a puzzling choice that captures the zeitgeist. What offers better inflation cover in 2021 – the time-tested security of gold, or the futuristic aura of bitcoin?
Whether that is a fair comparison is up for debate. There is a growing argument that it is, on the basis that the yellow metal and the original cryptocurrency share some key characteristics:
- Both enjoy scarcity appeal that has helped boost their value over the years – gold is limited in supply and so is bitcoin. Fresh issues of the latter halves roughly every four years and is expected to run out by the year 2140.
- Both find use as mediums of exchange, meaning you can swap them for goods and services.
The gold versus bitcoin debate is growing after a report earlier this month showed US inflation hit a three-decade high. Consumer price increases across the euro zone, Canada and the UK also have accelerated to speeds not seen in a long time.
Gold prices have a strong track record of doing well during periods of increased consumer price pressures – the commodity rallied almost 2,400% during the 1970s, the decade of the Great Inflation. Yet, the precious metal’s performance this year pales in comparison with bitcoin’s.
Speculative, or store of value?
It’s not an easy choice for investors. Gold, used as a store of value for millennia, has all that history in its favour. On the other hand, cryptocurrencies are often touted as the future, and championed by celebrity influencers such as Tesla CEO Elon Musk.
Even the US Securities and Exchange Commission, the markets regulator, recently acknowledged bitcoin’s growing appeal to the investing public.
“Bitcoin… is a highly speculative asset, but it is a store of value that people wish to invest in as some would invest in gold,” SEC chairman Gary Gensler said last month in a testimony to the US House Committee on Financial Services.
Indeed, bitcoin has massively outperformed gold in 2021, as the economies of the world braced for the worst inflation shock in a long time.
It has rallied more than 90% this year, hitting a record high near $69,000 (£51,500) earlier this month before retreating to levels below $60,000. Bullion lost about 5% of its value in the same period.
What is your sentiment on Gold?
Stability versus volatility
But gold isn’t just an inflation hedge, it’s also a safe haven – meaning it’s an asset that investors like to accumulate during periods of heightened economic uncertainty. And that’s largely because of the precious metal’s strong track record of price stability.
Bullion continues to play an important role in the world economy, with about one-fifth of it being held by central banks to be used as collateral. Adding to gold’s appeal is the fact that it doesn’t tarnish or corrode, boosting its utility in various industries including jewellery.
Bitcoin, in comparison, scores rather poorly on stability. The digital token, like other cryptocurrencies, is notorious for its high volatility and low predictability – a trait highlighted by skeptics of its utility as an inflation hedge.
What do experts think of the bitcoin versus gold question? Here’s a selection of recent analyst commentary on the matter.
J.P. Morgan: bitcoin is far more volatile
The current crop of cryptocurrencies, including bitcoin, are “unsuitable as currencies and unlikely to ever be widely used as a medium of exchange. They look like highly speculative assets, with high volatility, unreliable correlations and a significant risk of their values eventually falling to zero,” strategists at J.P. Morgan Asset Management led by David Kelly wrote in a recent report titled Long-Term Capital Market Assumptions 2022.
Below is a selection of comments from the note.
- The high volatility of cryptocurrencies makes them poorly suited to the three traditional uses of a currency: as a store of value, as a unit of account and as a medium of exchange.
- Bitcoin hasn’t exhibited the characteristics of a safe-haven asset. Like gold, bitcoin is not issued or controlled by any entity, institution or government. That characteristic has allowed gold to serve as a safe haven during some periods of increased political and economic uncertainty. Bitcoin has been far more volatile than gold.
- Bitcoin has demonstrated very unstable correlations with stocks and bonds, making it a poor choice as a portfolio diversifier. The volatility this cryptocurrency delivers dominates and overrides the majority of the risk-return benefits.
StanChart: bitcoin volatility a hindrance
Standard Chartered analysts, who tested bitcoin for the three economic requirements for a currency, published their findings in the bank’s Bitcoin Investor Guide in September. Here are some of their observations:
- Store of value: The finite supply of bitcoin may underpin its potential to be a store of value. Its short-term supply is elastic while long-term supply is fixed. Long-term price stability is needed for it to continue to be a store of value.
- Medium of exchange: Its short-term volatility impedes its practical use as a medium of exchange.
- Unit of account: Bitcoin's volatility hinders it ever being used to value other goods and services.
The analysts also highlight regulatory issues surrounding the use of bitcoin, pointing out that any government would need to focus on three broad areas when it comes to financial markets: countering illicit activities, ensuring financial stability and protecting the investors.
So far, countries have gone different ways on this, with China banning crypto mining while El Salvador gave legal-tender status to bitcoin.
Gold, bitcoin ‘can complement each other’
Here are excerpts from a report published last month by Bloomberg Intelligence analysts James Sayffart and Eric Balchunas.
- Rather than positioning bitcoin and gold as polar alternative assets, they can complement each other in a portfolio. Bitcoin is more transportable and divisible, and more applicable as a currency. But gold is more stable, with a proven track record. Both offer virtually no correlation to traditional asset classes. Still, bitcoin is currently most aptly characterized as a speculative asset.
- Gold and bitcoin have different long-term US tax rates. Bitcoin is taxed in the same way as stock ownership, with a long-term capital gains rate of 0-20%, depending on income level. Gold is taxed as a collectible and therefore carries a long-term rate of 28%, irrespective of an investor’s income.
- Bitcoin is superior to gold as a medium of exchange or form of payment. Unlike gold, it is a fixed unit of account and easily divisible and transportable. Gold isn’t easily divisible on the spot, and there are potential issues with purity and verification. The ability to trace bitcoin on blockchain ledger technology will likely prove to be a substantial advantage, especially in cross-border transactions.
- Bitcoin’s price volatility and history of drawdowns limit its use as a store of value, and even as a form of payment.
‘Speculative, rather than store of value’
Here are some excerpts from a study published this year by researchers from the UK’s Claude Littner Business School, Kent Business School and the Centre for Distance Education.
- Bitcoin is often identified as new gold. However, cryptocurrencies do not appear to perform their function as currency, as a medium of exchange or store of value. They have been too volatile that may lead to deflation in the economy.
- Also, under the ESG framework, it is quite costly due to high power consumption, being too technology-intensive for masses to adopt, and non-transparency in the exchange mechanism with no system of redress.
- Bitcoin’s price movement compared with that of gold, which has acted as a hedge over centuries, shows no relationship. Bitcoin has very high volatility when compared to S&P 500, gold and the TLT ETF. Hence bitcoin is acting more as a speculative asset rather than a steady store of value.
Now let’s take a quick look at some key facts and historical aspects that have helped shape the markets for gold and bitcoin.
The gold standard
Gold was the basis of a monetary system known as the gold standard, used internationally from the 1870s to the early 1920s. Britain was the first to enter this system in 1717, when Sir Isaac Newton, the then master of the Royal Mint, set a low exchange rate between gold and silver.
Some of the drawbacks of pegging currency to gold were the commodity’s unequal distribution and short-term price volatility. This method was eventually discontinued due to the volatility it caused.
Today, global central banks have mostly moved away from the gold standard, but bullion reserves are still maintained, largely to be used as collateral for borrowings. The US has the largest gold reserves, over 8,000 metric tons, followed by Germany with around 3,300, and France and Italy both having around 2,400.
In a 2020 survey by the World Gold Council, central banks cited the top reason for them to keep their gold reserves as the metal’s performance during periods of economic crisis, along with their histoical positions. Such deep economic dependence on the metal may help secure its long-term value.
Gold’s value is also underpinned by its scarcity. Below is a break-up of all above-ground stocks of the metal as of end-2019, as well as estimated ground reserves, according to data published by the World Gold Council:
- Jewellery – 92,947 tonnes, or 47% of above-ground stocks
- Private investment – 42.619 tonnes, 21%
- Official holdings – 33,919 tonnes, 17.2%
- Other: 28,090 tonnes, 14.2%
- Below ground reserves: 54,000 tonnes
Since 2014, gold has mostly underperfomed stocks, while bitcoin outperformed up until recently.
Bitcoin gains wider acceptance
Since its inception in 2009 by an unknown person or group known by the name Satoshi Nakamoto, bitcoin’s appeal has been that of a decentralised digital currency that can be exchanged on a peer-to-peer network without intermediaries.
The virtual coin is traded on an open-source technology known as blockchain. The number of bitcoins that can be created is finite. There can only be 21 million in circulation, and that number is estimated to be reached in 2140.
The virtual currency’s price rose to an all-time high last month following the launch of the first US exchange-traded fund for the asset: the ProShares Bitcoin Strategy ETF.
A survey conducted by Fidelity between December 2020 and April 2021, showed a positive change in the perception of digital assets, with almost 9 out of 10 investors finding them appealing. Many investors see volatility, a lack of fundamental valuation and a heightened risk of market manipulation as the three concerns that hinder the wider adoption of digital assets, according to the survey.
Can bitcoin become a ‘digital reserve asset?’
“The question might be what stops the process of bitcoin becoming global digital collateral,” Mike McGlone, a commodity strategist at Bloomberg Intelligence, said in emailed comments. “It’s too volatile now, but demand, supply, adoption and declining volatility trajectories point to increasing depth and liquidity for bitcoin to replace gold as the digital reserve asset, in a world going that way.”
The method of mining bitcoin is set up in a way that cuts the cryptocurrency’s new supply in half roughly every four years, boosting its scarcity appeal. All such halving periods, especially the recent two, were followed by substantial increases in bitcoin prices.
Still, with heightened concerns over the digital token’s short-term volatility, any investments in bitcoin may need a long-term horizon, much like gold.
“Regulatory clarity should be a 2022 hallmark,” said McGlone. “Most countries will maintain their own currencies, but bitcoin fits well in diversified portfolios including gold and bonds. Bond yields are the lowest in history and bitcoin offers logical diversification.”
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