(Note: This article assumes some knowledge of the Cyprus Crisis, for more on that issue see my recent article here.)
By now everyone has heard about Cyprus, Italy, and the EU’s continuing battle to hold itself together (which frankly reminds me a lot of Sisyphus and his perpetual struggle to roll a boulder up a hill, but that’s another story). However, one surprising result of the increased attention to the EU has been the relatively muted response in gold (GLD) and gold miners like Goldcorp (GG), Newmont Mining (NEM), Barrick Gold (ABX), Yamana Gold (AUY), Kingross Gold (KGC), and a herd of other smaller miners.
Historically, gold and to a lesser extent silver and the gold miners have displayed a strong negative correlation with the rest of the market. On some of the worst days in 2008, virtually the only S&P 500 companies in the green were the gold miners. This negative correlation between gold/gold miners and the rest of the market was extremely valuable for investors because it enabled them to easily hedge their portfolio without having to take on short positions. The correlation coefficient between the gold miners and the broader stock market over the last 5 years is -0.68. (See my blog for a further discussion of correlation coefficients over time and using correlations in market hedging). Essentially this just reinforces the casual observation that when the markets are down, gold and the miners are up. OK, so chaos is good for safe haven assets like gold, so what’s the problem?
I think there is something else happening to the price of gold; something that isn’t yet widely discussed, and which affects the value of gold as an investment asset. Recently, a CNBC reporter was discussing gold and espoused the view that gold is no longer a safe haven asset. Instead, the reporter’s view was that gold has become securitized and now deserves to be treated like a common ETF asset rather than a separate store of value. But if this is the case, what are people using as a safe haven asset instead? Well, I’ll get to that in a minute, but first let’s talk about the recent performance of gold and the miners.
In the last 6-12 months, miners and gold in general have been performing abysmally. Part of this is because the stock market is up, but it is also worth noting that even on down days, miners and gold itself have frequently been down, or at best neutral. For example, Barrick Gold is off 20%+ in the last 3 months, and it hasn’t seen any substantial rally even with the increased uncertainty surrounding Europe. Similarly, the correlation coefficient between gold and the markets has come down from around -0.7 to around -0.4 in the last month or so. So what is happening to gold? Is the price just going to keep dropping due to the metal falling out of favor as hedge funds and other investors bailout and return to equities or fixed income?
Well in theory, if inflation rises as the economy recovers, then gold should also start to recover. Most analysts don’t see the metal falling much further this year, and some suspect it will rise. For example, Goldman Sachs is forecasting a 2013 price of $1,600/oz, while Bank of America has a price target of $1,680/oz. Similarly, many analysts are optimistic about the miners with CSFB and S&P both viewing miners like positively.
However, while I think the long run value of gold is probably fine, the metal may have lost some of its value as a safe haven because of a new alternative safe haven currency: Bitcoins. Now before we go any further, let me state clearly and for the record, that I am NOT advocating Bitcoins as an investment. I don’t have a view on their value one way or the other, but I do think they are drawing some traditional holders of gold and thus lowering the price of gold.
For those who aren’t familiar with Bitcoins, they are an electronic currency that trade completely online. They are not backed by any national government and in theory they have a fixed supply so their value can’t be altered by governments or individuals. (That said, I’m not an expert on computer hacking, but it seems conceivable that a clever hacker could go online and “counterfeit” more Bitcoins thus increasing the supply and diminishing their value. Again though, I’m not a computer hacking expert, so I have no idea how feasible that is.)
Bitcoins have been in the news a lot lately as their usage seems to be on the upswing. A couple weeks ago the Associated Press and the BBCreported on a man in Canada who was selling his house and was willing to take Bitcoins in payment. Newsoutles have written stories about the use of Bitcoins by Iranians and North Koreans to avoid sanctions. The U.S. government even began issuing regulations surrounding the trade in Bitcoins and what legal requirements must be followed. With the increase in this type of stories, it shouldn’t be a surprise that Bitcoins have increased in value (greater demand, same supply = higher price). However, what is noteworthy is that Bitcoins seem to have usurped at least some of gold’s status as a safe haven asset around the Cypriot Crisis.
The use of Bitcoins seems to have increased dramatically in Spain, Italy, Greece, Cyprus and elsewhere in Southern Europe over the last two weeks. This is most likely driven by increased concerns about the future value of the euro. Historically, these kinds of concerns would have had investors headed for the safety of gold. Instead, the value of Bitcoins has shot up in relation to the euro. The chart below shows the price of a single Bitcoin in euros. (All charts come from here: The right side axis is the price per Bitcoin, the left side axis is the volume on a given day).
What the chart details is that the value of Bitcoins, and the average transaction volume have both increased dramatically since Cyprus started making headlines. A similar chart for the Japanese yen shows the value of Bitcoins increasing after Abe became Prime Minister and started pushing to reinvigorate the Japanese economy by reversing that country’s crippling deflation.
Now, neither of these charts alone is conclusive evidence that Bitcoin prices are responding to economic distress, and certainly there isn’t enough data to say with conviction that Bitcoins are becoming even a partial substitute for the massive market in gold. To “prove” either of these things, I would need substantially more data in order to run a battery of multivariate regressions (Again, see my blog for more details on using multivariate regressions in investing). That kind of data simply isn’t available at this time.
Instead, my point is simply to advance what I view as a plausible hypothesis: It is possible that Bitcoins are starting to steal some of gold’s historic role as a safe haven asset, and if that comes to pass it will be a headwind for the metal and the miners of it going forward. In fact, there is some small possibility that hedging market risks in the future may be done in part with Bitcoins, and that would be a major change from the past with enormous ramifications for markets and monetary policy.