2017 is the eighth-straight year in a bull market, but skeptics warn this can't last forever, with some even arguing that we are mirroring the run-up to the Great Recession. What’s a savvy investor supposed to do?
The traditional move would be to hedge against stock volatility with gold. This has proven an effective method in the past, but a new alternative is challenging the old-school safe-haven. Bitcoin is a flashy new asset with all the properties of a currency, but with some unique features that make it a viable haven. These differentiators, along with a vocal and loyal backing, have led Bitcoin to become an alternative means to reduce exposure to stocks safely.
Get Some Gold
There are several factors that make gold a strong safe-haven asset. It’s valuable as a material for consumer goods such as jewelry and electronics, and it is scarce. Regardless of demand, supply remains disproportionately low. Gold cannot be manufactured like a company issues new shares, or a federal bank prints money. It must be dug up from the ground and processed.
Accordingly, gold has almost no correlation with assets like currencies, and stock indices such as the S&P500. The precious metal used to be tied to the Dollar until 1971 when President Nixon severed the ties between the US currency and gold as a base. Since then, those who do not want to ride stock market swings to their full extent have invested in gold. The precious metal helps soften the blow or even profit when there’s a stock market correction, defined as a decline of 10% or more. As seen in the chart below, gold is a good asset to have in a bear market.
Gold usually performs well during corrections because even if it doesn't’t necessarily rise, an asset that remains static while others decline is quite useful as a hedge. Plus, as more people flee stocks and invest in gold, the price rises accordingly.
Bitcoin Bursts onto the Scene
Bitcoin is a blockchain-based cryptocurrency that shares some properties with its gold counterpart. In fact, many have called Bitcoin “digital gold” in the past due to its weak relationship with all other assets–stocks especially. Market participants may remember last year when the price of one Bitcoin surpassed that of a single troy ounce of gold for the first time. Currently, Bitcoin’s price is near $4,000, but how is it so valuable? More importantly, should those running from stocks consider investing in the cryptocurrency?
Like gold, there is a limited amount of Bitcoin. It must be mined , though not with drilling machinery. Instead, the digital currency is mined with the total computer power of its vast network of users, who process transactions on the blockchain for a small amount of Bitcoin. At an estimated cap of 21 million Bitcoins, demand has a magnified effect on the cryptocurrency’s price.
Comparing the Two
For hundreds of years, gold has dominated the safe-haven asset arena, and it is yet unknown if Bitcoin presents a real threat. There are some small, but potentially significant differences between Bitcoin and Gold in 2017:
Transparency, Safety, Legality
Gold’s established system for trading, weighing and tracking is pristine. It’s very hard to steal it, pass off fake gold, or otherwise corrupt the metal. Bitcoin is also difficult to corrupt, thanks to its encrypted system and complicated algorithms, but the infrastructure to ensure its safety is not yet in place. The Mt. Gox disaster is a good example of why Bitcoin traders must be wary. In this disruptive event, a popular exchange went offline, and all but stole its users’ Bitcoins, totaling around $460 million. Legally, there are few consequences for such behavior, as Bitcoin remains difficult to track with any level of efficiency.
Gold can continue to be mined, but eventually there will be no more Bitcoin. The algorithm that manages the blockchain rewards miners for verifying and processing transactions, but in as little as 10 years, the supply will run out. This higher level of scarcity means that Bitcoin could have a higher price ceiling than gold and is the most important catalyst for the current speculative bubble.
While gold is physically useful for jewelry and industry, Bitcoin’s applications are not yet clear. So far, it is a digital instrument of speculation and value transferability, but it is difficult to buy things with and has limited utility as currency. Being an exclusively faith-based currency is price-positive when there is popular support, but the opposite might also be true. There’s not much stopping Bitcoin from hitting $0 other than belief. As the world saw during the Dutch Tulip Mania, this could have adverse consequences.
Largely due to the properties above, Bitcoin is more volatile compared to gold. As price increases, people’s opinions on the revolutionary currency become stronger than ever. This newfound confidence will accordingly cause wild price swings. “There have been very volatile days on the market since Bitcoin crossed the $2000 rate”, says Yoni Berger, analyst at CryptoPotato, a news site dedicated to exploring current issues regarding Bitcoin and other alternative cryptocurrencies.
It’s much easier to get cash for gold than cash for Bitcoin. In the limited number of exchanges that allow fiat withdrawal, all impose daily limits, meaning that Bitcoin is not as liquid as it could be. People world-wide gold and are willing to pay for it while Bitcoin’s market is limited.
(For related reading, see: As Investors Turn to Cryptocurrencies, Gold Suffers)
How to Balance Your Portfolio?
In the face of a declining stock market, which is better for one’s portfolio: Bitcoin or gold? Gold is still a winner though that could change soon. Gold is always a smart addition to any portfolio due to its historical reliability and real value, but Bitcoin is starting to become a worthwhile option. Modern investors would be smart to keep a small amount of both in their account, but should also be wary of over-investing in a currency with an opaque future. If Bitcoin can prove its value, however, gold may have a real competitor for the safe-haven asset of choice.