A highlight of 2017 financial markets has certainly been the explosion of interest in cryptocurrencies. We attribute growing interest in digital currencies to a concern shared by many gold investors. In short, resentment is mounting over the financially repressive policies of global central banks. Specifically, the imposition of negative interest rates and related official backing of increasingly cashless economies have catalyzed interest in investment vehicles outside the traditional financial system, such as precious metals and cryptocurrencies. Along the way, comparisons of bitcoin to gold have become all the rage. Because spot gold has spent the past five-and-a-half months trading within a $100-range, while the prices of cryptocurrencies have soared, some have even suggested that digital currencies are usurping gold’s role as preferred store of value.
It will come as no surprise that at Sprott, we assess the investment merits of gold and bitcoin to be substantially different. We view gold in its traditional profile as reliable store of value and productive portfolio-diversifying asset. In contrast, while we recognize that bitcoin is the first killer application of the epically disruptive blockchain technology, we view bitcoin’s current investment merits as limited to potent speculation. We absolutely believe bitcoin can play a productive role in many portfolios, but that contribution will be entirely different from that offered by gold. In this report, we have organized our thoughts around seven key differences between gold and bitcoin as portfolio assets.
Bitcoin is the market leader in the emerging asset class of digital currencies. Importantly, bitcoin is based on blockchain technology, which is essentially a distributed database used to maintain a constantly growing list of records, called blocks. Each block contains a timestamp and a link to the previous block.
In essence, the blockchain permanently stores a history of all previous transactions and participants and is simultaneously updated across a vast array of global computers to provide instant and fully transparent proof of authenticity to all users. By all accounts, the blockchain is potentially the most disruptive technology since the advent of the internet. Its applications are virtually limitless. However, it is important to differentiate between the blockchain and bitcoin. They are not one and the same. Bitcoin is simply the leading brand in the blockchain’s first emerging application (digital currency). While bitcoin’s lead in the cryptocurrency market is currently substantial, there is no guarantee bitcoin will ultimately prove to be the widely adopted crypto winner. Bloomberg (7/12/17) informs us that a grand total of three of the 500 largest internet merchants currently accept bitcoin for payment, down from five one year ago. The digital currency industry is in its early infancy, and many of the world’s smartest and most resourceful scientists, entrepreneurs and financiers are laser-focused on developing superior technologies to address bitcoin’s perceived shortcomings. It is ironic that Mark Andreessen, one of the most powerful voices for the blockchain and cryptocurrencies, was also a cofounder of Netscape. Just as Netscape was once the undisputed market-leading browser in an emerging technology called the internet, bitcoin is now the undisputed market-leading crypto in an emerging technology called the blockchain. It is far too early for definitive evaluation of bitcoin’s long-term prospects, much less to compare bitcoin to gold as a store of value!
Quite simply, gold is gold. For over 5,000 years, an ounce of gold has been exactly the same: an ounce of gold. There are no variations or imitations. Central banks hold gold because of its extraordinary density, rarity and immutability. Central banks do not hold diamonds or priceless art because of their infinite variability.
There is no society on earth which does not regard gold as valuably precious. Gold is virtually indestructible. Only a few very powerful acids can destroy it, and gold does not even melt below 1,943 degrees Fahrenheit. Gold never tarnishes. Gold is immutable.
Bitcoin, in comparison, is a string of code generated by software protocols and cryptographic algorithms. While a sophisticated programmer might take comfort in the technological impregnability of the blockchain, this type of intellectual security eludes many investors outside the Bay area and lower Manhattan. In essence, bitcoin is shrouded in a dense cloak of ambiguity because few people comprehend the underlying protocols. Of course, this does not prevent legions of speculators from flocking to bitcoin’s often irresistible chart pattern. That is a given in contemporary, correction-resistant markets. As far as a store of value for accumulated wealth, however, we have yet to encounter significant investor testimonial on bitcoin’s behalf. With respect to bitcoin’s immutability, we are somewhat troubled that the operation of the bitcoin network is becoming increasingly concentrated in the hands (actually the massive computer farms) of a limited number of programmers. Because humans always eventually do what is best for themselves, this concentration may lead to unforeseen changes in the bitcoin network, perhaps a lot sooner than most recognize (more on this later).
Because gold investment decisions are often fueled by emotion, precious metals have earned a reputation for volatility. Gold’s commodity characteristics expose the metal to the trading patterns of limits, stop losses and the aggressive trading tactics popular on the COMEX. Additionally, over long spans, gold can post high-percentage moves reflecting changing economic and monetary conditions. From a 2/16/01 low of $253.85, spot gold climbed 656.81% to a 9/6/11 high of $1,921.15, before falling 45.53% to an intra-day low of $1,046.43 on 12/3/15. Of course, these moves took ten-and-a-half years and four-and-a-quarter years, respectively, to unfold. Despite these high-percentage changes, gold has remained throughout the years an effective store of value as measured by a myriad of divisors, from the cost of a men’s suit, to barrels of oil and everything in between.
The extreme volatility of the cryptocurrency asset class, to us, belies any legitimate role as store of value. Figure 1, on the following page, plots the percentage losses for the leading 50 digital currencies during the three weeks ended 7/16/17. Admittedly, these declines occurred after spectacular multi- month gains (in many cases by many-hundreds-of-percentage- points). Nonetheless, no asset class with broad-based declines in a three-week period measuring between 40% and 70% should logically be confused with a store of value.
With respect specifically to bitcoin’s volatility, roughly every year or so the currency experiences a rapid upward shock, followed by an equally rapid downward correction, reminding us far more of an enticing trading opportunity than a store of value. In one particularly vertiginous run in late 2013, bitcoin exploded 446% in less than a month from an 11/1/13 close of $208.18 [Bloomberg BGN “close” is 5 pm EDT] to an 11/29/13 close of $1,137, before falling 53% to a 12/17 close of $533.71. More recently, on 3/2/17, bitcoin ($1,257.94) surpassed the spot gold closing price ($1,234.31) for the first time, before catapulting to $2,999.98 on 6/12/17. From the shape of things in Figure 2, below, bitcoin appears to be rapidly unwinding early summer gains. We suspect many millennials are