A few days ago we first showed a chart of a dramatic divergence between the price of gold and bitcoin...
... which together with a recent unscientific poll showing that more Ron Paul followers prefer bitcoin to gold...
A wealthy person wants to gift you $10,000. You get to choose in which form you'll take the gift. But there's a catch: You must keep the gift in the form that you choose, and you can't touch it for 10 years.— Ron Paul (@RonPaul) December 5, 2017
In which form would you take the gift?
...prompted many to wonder if bitcoin - whether it is a commodity, currency, commodity-equity hybrid as some suggest, or simply a bubble as its opponents claim daily - was stealing demand for gold.
In an overnight note, Goldman's global head of commodities Jeffrey Currie answered this question, arguing that despite bitcoin's "explosive upward trajectory" the answer to whether "bitcoin is taking demand from gold” is no, and gives three reasons why there is a lack of substitution by investors from gold into bitcoin:
- First, the investor pools are vastly different. Gold investors who use ETFs, futures or commodity indices are automatically covered by anti-money laundering (AML) and counter-terrorist financing (CTF) regulations which are already “baked in” to processes in these markets. Even physical trading in jewellery, bars, coins etc. has seen a huge increase in regulatory scrutiny, globally, over the last few decades. In the US, professional jewellers and dealers must have an AML program implemented, and significant cash purchases or precious metal sales require additional reporting to the IRS on a transaction by transaction basis. In contrast, there is still very little clarity on how trading in cryptocurrencies could be made to comply with AML and CTF regulations, even in theory. This creates huge regulatory hurdles for professional investors wishing to enter these markets.
- Second, as the chart below shows, there has been no discernible outflow of gold from ETFs. Indeed, total known gold ETF holdings recently reached their highest level since mid-2013 (currently up 12% YTD, see Exhibit 8). This is somewhat related to the first point, as mutual funds are the largest holders of gold ETFs, but even accounting for this there is no evidence of a mass exodus from gold.
- Third, and final, the market characteristics of gold and cryptocurrencies are vastly different Currie claims. In this context, th emarket cap of bitcoin is still just under $300 billion, while the total value of gold is a little over $8 trillion. And while bitcoin has a mathematically certain total supply, and gold has a finite (but less certain) supply in the earth's crust, even a cursory examination shows very different market dynamics according to Currie. As a result, Goldman believes that the composition of demand between bitcoin and gold is the key difference in the recent price action, and specifically, bitcoin is attracting more speculative inflows relative to gold.
Putting all this together, Currie concludes that bitcoin has demonstrated much higher volatility and lower liquidity / price discovery compared to gold.
"The market cap of bitcoin is c.$275 billion versus gold at $8.3 trillion. Even all of the cryptocurrencies combined have a market cap less than $500 billion. While the lack of liquidity and increased volatility may keep bitcoin interesting, it is unlikely to convince investors looking for the kind of diversification and hedging benefits which gold has proven to possess over its long history."
Unless it is successful, of course, in which case there is a little under 20x upside for the crypto sector.
Currie does make a good point in his conclusion: "to deal with the AML and CTF uncertainties surrounding bitcoin, and attract a wider investor pool, custody issues must first be resolved beginning with identifying it as a commodity, fund or security." Here Goldman "firmly believes" that bitcoin is commodity, "as bitcoin has no liability that all securities have by definition. Even a dollar bill is ultimately a liability to the US government."
Which is also why demand for bitcoin is so exponentially greater than demand for a dollar bill.