As performance continues to drive enthusiasm for bitcoin and other cryptocurrencies,1 headlines have trumpeted bitcoin as the “new gold,” an asset to serve as the new preferred store of value and risk hedge. In response, we’ll paraphrase Mark Twain: “The reports of gold’s demise are greatly exaggerated.”
Exploring critical and fundamental differences between gold and cryptocurrencies shows that they are two distinct asset classes - and underscores why demand for gold will persist.
Gold’s Advantages with Demand and Supply
Gold’s history is as rich and ancient as the material itself. Civilizations have mined and used gold for at least 6,000 years,2 initially spurred by the metal’s beauty; its rarity helped gold evolve into a symbol of prestige, wealth and power. In contrast, bitcoin surfaced in a nine-page white paper “Bitcoin: A Peer-to-Peer Electronic Cash System” from a mysterious pseudonymous creator (Satoshi Nakamoto) on the heels of the Great Financial Crisis to disintermediate banks from financial transactions by using a decentralized network called the blockchain.
As a commodity with real world utility, gold’s intrinsic value does not rely solely on its use as a form of money (functioning as a store of value, unit of account, and medium of exchange). As a unique element, gold is used across a myriad of applications in technology and industry. Most prominently, gold is used for jewelry, which accounts for half of annual gold demand on average. In fact, most of the annual gold demand (58%) is tied to these tangible consumer and industrial applications.
On the other hand, bitcoin lacks this real-world utility, and its value depends solely on its adoption and use as a form of fiat currency.
Figure 1: Real-world Applications and Consumption Account for Most Gold Demand
Furthermore, global central banks over the past decade have accounted for 12% of annual gold demand. These banks currently hold an estimated US$ 2 trillion in gold bullion as a reserve asset.3 Central banks and other official sector institutions value gold’s homogeneity, liquidity, stability, and lack of default risk as a core attribute for reserve management and diversification and therefore maintain a portion of their reserves in gold alongside major fiat currencies like the US dollar, euro, and Japanese yen.
Meanwhile, most central banks have not determined the legality or applicability of bitcoin. El Salvador is the only country that has recognized bitcoin as a legal tender alongside the US dollar, which for years had served as the country’s sole official currency. Other central banks are closely monitoring the outcome of the uncharted experiment while investigating digital versions of their own currencies. Central bank digital currencies, or CBDCs, could be used through apps on a digital wallet for people and businesses to transact with each other. People’s Bank of China (PBOC) has already launched pilot programs to test their CBDC financial stability while outlawing the use of bitcoin.
On the supply side, both gold and bitcoin are inherently scarce, one determined by mother nature and the other by a mathematical algorithm. It should be noted, however, that new gold supply from mine production was 1.7% in 2020 – a growth rate essentially unchanged for the past 20 years.4 The growth rate in bitcoin supply, however, has remained well above or comparable to this level to date, even as market capitalization and price have risen dramatically since its inception. From a rate of increasing supply, this points to gold remaining a scarcer commodity.
Gold’s Solid Store of Value Means Relative Stability
Bitcoin’s high volatility, limited liquidity, and lack of both transparency and global regulation are indicators that it falls short as a store-of-value asset. When evaluating asset volatility over the past 10 years, bitcoin is clearly not in the same class as major reserve currencies such as the US dollar (USD), euro (EUR), yen (JPY), or pound sterling (GBP) shown below. Nor is bitcoin comparable to gold and other major commodities that maintain ample global liquidity. Bitcoin’s 121% annualized historic volatility is closer to the volatility of the VIX Index than to gold’s 15% or the 9% average of the seven major currencies.5
Figure 2: Bitcoin Eight Times More Volatile than Gold
Furthermore, bitcoin’s volatility in recent years also remains persistently elevated compared to gold and other major assets classes, despite its rising price and market cap.
Figure 3: Bitcoin Volatility Is Extremely High Compared to Gold, US Equities, and the US Dollar
Diversifying with Gold Provides Downside Protection During Tail Risks
As highlighted in Gold: The Original Liquid Alternative, gold maintains not only a persistent low correlation to stocks and bonds, but also a low beta. While the returns of bitcoin may have improved portfolio returns, its levered sensitivity to equity and risk factors alongside high volatility may not aid in reducing portfolio volatility like gold does. This is a consideration to keep in mind if bitcoin’s price performance slumps like it did in 2018.
Historically, gold has served as an effective hedge against heightened volatility, geopolitical turmoil, and significant risk-off events resulting in equity market drawdowns. During market drawdowns of 10% or more, gold has increased on average 5.1% while bitcoin has behaved directionally with risk assets by decreasing on average -33.11%6
Figure 4: Gold Historically Has Provided Protection During Significant Market Downturns
Differing Investment Motivations and a Look Ahead
While gold may provide positive risk adjusted real returns, one of the primary motivations for investing in gold is defensive in nature. Investors are commonly motivated to include gold in portfolios for its risk management and downside protection capabilities, including a persistent low correlation to other financial assets, ability to hedge against severe market and economic downturns, and as an efficient source of portfolio diversification to support risk-taking. Conversely, bitcoin investors are primarily motivated by the opposite - speculation and upside-potential. And, to date, investor interest and activity in bitcoin has occurred during periods of extreme price momentum. These different motivations further support the notion that investors should view gold and bitcoin as distinct asset classes with differing investment utilities.
Headlines, pundits, and proponents continue to forecast only clear skies ahead for bitcoin and cryptocurrencies, urging investors not to focus on performance gains to date or the risk of permanent loss because “this time is different.” Diverging performance between bitcoin and gold in 2021 also has sparked a narrative that investors are abandoning gold in favor of bitcoin. Many point to recent gold investor outflows alongside rising bitcoin price and demand as evidence of this trend. In this case, however, correlation does not equal causation. With an average correlation of -0.03 between gold ETF holdings and the price of bitcoin (see Figure 5), the narrative that investors seek to replace their gold allocations for bitcoin misses the mark.
Figure 5: Gold ETF Flows and Bitcoin Price Lack Any Persistent or Significant Relationship
The relationship between bitcoin and gold investor flows (as measured through changes in global gold ETF holdings) are statistically insignificant and lack explanatory power, showcasing an R-squared of only 0.01% over the last five years.
Figure 6: Gold Investor Flows Are Not Explained by Bitcoin’s Performance
Bottom line: Gold has a long and storied track record of providing several unique and beneficial investment characteristics. While bitcoin mania has resulted from a meteoric price rise,7 it remains a speculative risk asset as questions about its long-term viability and regulatory treatment persist. While it may be too soon to tell if bitcoin is a viable long-term investment like gold, it is clear that they are separate and distinct assets that investors should not view as interchangeable in portfolios.
1Bloomberg Financial L.P., & State Street Global Advisors, date as of October 15, 2021. Bitcoin’s YTD performance is 130%. 2The World of Gold, 1968, Timothy Green. 3International Monetary Fund, as of August 31, 2021. 4World Gold Council, Metals Focus, Refinitiv GFMS, date as of December 31, 2020. 5Bloomberg Finance L.P., State Street Global Advisors. Data from 07/31/2010 – 10/15/2021. USD = US Dollar Spot Index, CAD = Canadian Dollar Spot Index, GBP = British Pound Spot Index, EUR = Euro Spot Index, JPY = Japanese Yen Spot Index, AUD = Australian Dollar spot index, CHF = Swiss Franc Spot Index, Gold = gold spot price, Copper = COMEX Copper front month futures contract, Silver = silver spot price, Oil = NYMEX WTI Crude front month futures contract, Bitcoin = bitcoin spot price index. VIX Futures = CBOE Volatility Index Active Futures Contract. Past performance is not an indicator of future performance. 6State Street Global Advisors, World Gold Council. Data from 7/31/2010 – 10/15/2021. 60/40 Portfolio is 60% S&P 500 Total Return Index and 40% Bloomberg Barclays US Aggregate Index. Past performance is not an indicator of future performance. 7Bloomberg Financial L.P., & State Street Global Advisors, date as of October 15, 2021. Bitcoin’s YTD performance is 130%.
Bloomberg Barclays US Aggregate Bond Index
A benchmark that provides a measure of the performance of the U.S. dollar-denominated investment-grade bond market. The “Agg” includes public offerings in the US of investment-grade government bonds, investment-grade corporate bonds, mortgage pass through securities, commercial mortgage backed securities and asset backed securities.
A basic good used in commerce that is interchangeable, or “fungible,” with other commodities of the same type. Commodities are most often used as inputs in the production of other goods or services. For example, crude oil is a commodity that is used to make motor fuels, heating oil and lubricants.
The historical tendency of two investments to move together. Investors often combine investments with low correlations to diversify portfolios.
Dollar Index / US Dollar Index (DXY)
A currency benchmark that measures the performance of the US dollar against a basket of currencies: the euro (EUR), the yen (JPY), the British pound (GBP), the Canadian dollar (CAD), the Swiss franc (CHF) and the Swedish krona (SEK). Its shorthand symbol in financial markets is “DXY.”
Coefficient of Multiple Determination - The percent of the variance in the dependent variable that can be explained by all of the independent variables taken together. That is, the strengths of the independent variables of a regression are used to illustrate the value of the dependent variable.
Spot Gold Price
The price in spot markets for gold. In US dollar terms, spot gold is referred to with the symbol “XAU,” which refers to the price of one troy ounce of gold in USD terms.
S&P 500® Total Return Index
The version of the popular benchmark for U.S. large-cap equities that includes 500 companies from leading industries and captures about 80% coverage of available market capitalization in the US that reflects returns after reinvestment of dividends.
VIX Index or CBOE Volatility Index (VIX)
The VIX, often referred to as the equity market’s “fear gauge,” is a measure of market risk based on expectations of 30-day volatility. It is constructed using the implied volatilities of a wide range of S&P 500 index options - both calls and puts. The VIX volatility measure is meant to be forward looking.
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