Gold gains as China crushes cryptos

It has been an ugly day in crypto markets. Bitcoin is currently trading down 13% on the day at just to the north of the 37K mark, although prices are sharply off earlier session lows of just above the 30K mark, where the 200DMA (currently at close to 31.5K) helped to support the price action. That meant more than three and a half month lows for the world’s most popular cryptocurrency. Ethereum losses are even sharper at around 24% on the day, with the second largest crypto currency by market cap currently trading just to the north of the 2.5K mark, albeit having rebounded sharply from earlier session lows of under the 2K handle (at lows, Ethereum was a staggering roughly 45% lower on the day). Similar or even worse losses are being felt across other major alt. coins (Dogecoin -24%, Binance Coin -29%, Cardano -25% and XRP -24%).

For Bitcoin, Wednesday’s drop puts it on course for its worst day since March 2020 (the cryptocurrency dropped 39% on 12^th March amid widespread market terror over the international spread of Covid-19) and means the cryptocurrency is now down more than 40% from its 14^th April 2021 peak at just under 65K. Bitcoin came under selling pressure this time last week when Elon Musk announced that Tesla, the world’s most valuable automaker, would halt investments in the crypto asset amid concerns over the carbon footprint of the energy intensive Bitcoin mining that powers the Bitcoin network. He clarified that Tesla had not actually sold any of its Bitcoin, but this was not enough to stop the cryptocurrency from dropping below 50K.

As to latest drop in crypto markets, the catalysts was an announcement in China of a ban on financial and payment institutions in the country from providing cryptocurrency services. Under the ban, financial institutions, which include banks and online payments services, must not offer customers any service that involves cryptocurrencies, including registration, trading, clearing and settlement, three industry bodies in China said in a joint statement on Tuesday. China also warned investors in the country against speculative cryptocurrency trading. “Recently, crypto currency prices have skyrocketed, and plummeted, and speculative trading of cryptocurrency has rebounded, seriously infringing on the safety of people’s property and disrupting the normal economic and financial order” the statement from Chinese officials said. Note that this is not the first time China has acted to curb the cryptocurrency markets; in 2017, China ordered shut all local crypto exchanges which at the time accounted for more than 90% of global trading volumes, and in June 2019, the PBoC blocked access to all domestic and foreign cryptocurrency exchanges and Initial Coin Offering (ICO) websites.

One of the key reasons why crypto currencies had been performing so well in the tail end of 2020 and during early 2021 was a narrative that investment in and usage of cryptocurrencies was gaining wider spread acceptance amongst international financial institutions and in the business community. The fact that crypto is now essentially banned in China, the world’s second largest economy may be a harbinger of further government regulations ahead. Reportedly, some within the Biden administration are itching to tighten crypto market regulations in the US. Meanwhile, the hangover of Elon Musk’s decision to stop accepting Bitcoin as a form of payment may discourage other multi-national companies from investing in the cryptocurrency given its current not so great ESG score at present. In other words, recent developments have dealt a serious blow to narrative of the ever-greater mainstream acceptance of cryptocurrencies.

Note also that the Chinese central bank, (the People’s Bank of China) is hoping to soon roll out its own digital yuan, which some within the Chinese government hope might even be able to eventually supplant the US dollar as the world’s premier currency. Central banks across the world are increasingly looking into the possibility of rolling their own digital currencies. Naturally, the widespread usage of alternative, decentralised cryptocurrencies reduce the power of central banks to exert influence over their own economies through monetary policy, so there is an incentive to “take out the competition”. Anti-crypto talk from central bankers in Europe and North America suggests this motive may be widespread.

Crypto’s pain, gold’s gain?

For years now, it has not been uncommon to see “fans” and “proponents” of bitcoin call the cryptocurrency “digital gold” and advocate that holders of physical gold sell and buy bitcoin instead. Bitcoin is a store of wealth and hedge against inflation, or currency debasement, cryptocurrency community members have claimed. These characteristics thus put bitcoin in competition with gold and, though it has been hard to ascertain a direct correlation between the intra-day performance of gold and bitcoin in recent years, it did seem as though Bitcoin’s surge in late-2020/early-2021 weighed on gold.

This inverse correlation between bitcoin and gold has clearly been on display today, however. Even though the US dollar is stronger by about 0.2% and real yields are up (10-year TIPS yields are up about 2bps on the session), moves that would typically send gold about 1% lower, the precious metal actually trades higher on the day by about 1.0%. Amid the drop in bitcoin and other cryptocurrencies, spot gold (XAUUSD) has rebounded from earlier session lows in the $1850s and currently trades in the mid-$1880s.

In contrast to Bitcoin, which has been under pressure in recent weeks, gold has been performing well, boosted amid increased fears about inflation; the recent run higher in many commodity and raw material prices, combined with a recent much hotter than expected CPI report out of the US and indications in other data that higher prices and inflation concerns are damaging economic activity, have triggered concerns that the Fed may be making a mistake by continuing to pledge that it will hold interest rates at zero until 2024 and continue buying $120B in bonds for the foreseeable future. In other words, concerns are growing that the Fed (and US government which has implemented unprecedented fiscal stimulus) may be about to run the economy too hot, increasing demand for inflation hedges.

The fact that over the past few weeks, during which time these inflation concerns have really been peaking, bitcoin has done so poorly while gold has done so well seems to be making an impression on market participants. Perhaps bitcoin is not a good inflation hedge, some market participants might be concluding based on recent developments. Price action on Wednesday suggests that those seeking a hedge against inflation are choosing gold, not bitcoin.

How long will downside in crypto-markets last? Impossible to say of course. Perhaps the tide turns and the mainstream acceptance narrative that had been boosting bitcoin in recent months takes hold again and crypto markets recover. Perhaps some brave investors return to buying it as an inflation hedge. But one thing is for certain; investors are likely to always value gold as a store of wealth.