Why bitcoin will soon trade like gold on steroids.

 

Like personal computers in 1975 and the Internet in 1993, Bitcoin is a disruptive technology that is just beginning to go mainstream. But as revolutionary as the technology is, the most compelling thing about Bitcoin is its investment potential. No major investment asset in existence today has as much upside as bitcoin.

Since its invention in 2008 by the anonymous genius Satoshi Nakamoto, bitcoin has grown from an arcane technology known only to geek developers, to a cryptocurrency favored by the Libertarian fringe, to a legitimate investment, with a $10 billion market cap and over 200,000 transactions daily.

Bitcoin price Jan 3, 2009 through July 19 2016

But despite its steady growth, Bitcoin’s use in its infancy. A long list of tech luminaries view bitcoin-- and its underlying technology blockchain--as the future of commerce. Bill Gates, Sir Richard Branson, Executive Chairman of Google, Dr. Eric Schmidt and Paypal co-founder Peter Thiel as just a few very smart people backing bitcoin. Venture capital has discovered bitcoin in a big way, with the sector attracting over $1 billion in startup investment capital to date.

One of these investors is Marc Andreessen, developer of the first web browser and a seed investor in Facebook and Twitter. He’s arguably the greatest venture capitalist of the tech era, and he’s a bitcoin believer. Here’s what Andreessen had to say in a 2014 Washington Post interview:

“Bitcoin is in the early stages of mainstreaming today...You've got big companies that are not yet doing a lot with it, but are looking very seriously at it. So every big bank has people that are trying to figure out what to do with Bitcoin; every big e-commerce company has people that are trying to figure out Bitcoin. You have mainstream regulators figuring it out; you've got people at the Federal Reserve, and the Treasury Department and IRS that are figuring it out. At the state level, people are engaged on it. And so, it's in the early stages of mainstreaming.”

Another bitcoin devotee is Tuur Demeester, investor and publisher of MacroTrends, who is renowned as one of bitcoin's early champions, recommending it as an investment at $5 in January 2012.

“I think bitcoin and the crypto currencies are the greatest investment opportunity of our day and age,” he told Bitcoin Magazine in 2013, “...in contrast with traditional fiat money, Bitcoin is designed for the internet: it’s open source, it’s mobile, fast, and it allows for personal privacy.” He also added, “because we are approaching a bankruptcy event in the developed economies, both in banks and governments, I think that Bitcoin, as a discrete and non confiscatable currency, will benefit greatly from the capital flight that will ensue.”

Demeester’s view of bitcoin as not only a digital medium of exchange, but also as an investment that benefits from capital flight, is crucial. In fact, in it brief existence, bitcoin has seen three remarkable episodes of speculative frenzy due in part to its emerging use as a currency of last resort.

  1. April 1, 2011 $0.77 -- June 8, 2011 $29.60  Gain = 3800%
  2. Dec.  31, 2012  $13.41 -- April 9, 2013 $230  Gain = 1700%
  3. Sep. 30, 2013  $118.48 -- Nov. 25, 2013  $979.45  Gain = 826%

And now bitcoin is in the midst of another uptrend. From a late May low of about 440, bitcoin touched 768 just before the Brexit vote. 170% is a great move, but it may be just an appetizer for what’s to come.

Picture2.png

Bitcoin price Jan. 2, 2012 through July 19, 2016

Bitcoin's acceptance as a technology and investment is just now reaching critical mass. If the global economy unravels in the months ahead as many astute analysts believe possible, bitcoin could be a digital version of gold--an asset viewed as a currency of last resort, a place to park your money when things go south. Here’s one big difference though--there’s a few trillion dollars of investable gold out there.  Bitcoin’s market cap is currently $10 billion. Bitcoin may become gold on steroids. Get ready for the trade of a lifetime.

But for bitcoin to really go parabolic, there’s one big shoe that needs to drop. The key catalyst for bitcoin’s massive move is likely to be the country so often at the center of global market worries: China.

Desperate to maintain growth, with political stability ultimately at stake, the Chinese government has for years been creating money nonstop and pumping it into its economy. A consequence has been a gradually eroding yuan--down nearly 7% vs the dollar since the beginning of last year. Thousands of recently minted Chinese millionaires have seen their wealth gouged by the falling currency and are terrified of more losses down the road. In 2015, an estimated $1 trillion dollars of scared money left China. And most of it left illegally.

The Chinese government, concerned monetary outflows could turn yuan weakness into a rout, limit individuals to converting only $50,000 of yuan per year. So the Chinese people have been forced to get creative when it comes to money expatriation. Over and under invoicing of imports/exports, USD insurance schemes, Macau junkets, even old fashioned smuggling are among the strategies used to move funds from the mainland.

But in 2016, the Chinese government got serious, aggressively stepping up efforts to stop the outflows. By all indications, it worked. Outflows are down vs 2015. However, what happens if global markets deteriorate more, or if skepticism over the Chinese economy intensifies?

What would happen if the slow crawl of yuan devaluation were to suddenly become a free fall? If the Chinese people were anxious to expatriate their money during a 7% devaluation, what if there was a sudden devaluation many times that amount? The short answer: panic.

Which leads us back to bitcoin. With the Chinese government effectively sealing shut the exits for money expatriation, citizens desperate to get funds out NOW have few choices. An obvious answer is bitcoin. Getting your dough out of China is pretty much this simple: Deposit yuan in a bitcoin account and exchange the bitcoin overseas for some other currency.

The Chinese are already the world’s leading users of bitcoin by far. The Wall Street Journal reported in June that two Chinese exchanges, Huobi and OKCoin, accounted for 92 percent of global trading in bitcoin. It’s easy to envision a mad rush by the Chinese into bitcoin after a surprise RMB devaluation.

It is exactly this scenario that has prompted Mark Hart, a Texas-based hedge fund manager, to buy bitcoin. Hart, famous for making hundreds of millions of dollars betting against subprime mortgages in 2008 and shorting Europe in 2010, believes China will dramatically devalue the renminbi, allowing its currency to catch up with global economic reality. As he see’s it, either China devalues the yuan in one fell swoop or the country sustains an ongoing slow devaluation with increasing debt defaults and accelerating capital outflows. It would be like ripping a bandaid off--immediate pain, but over quickly.  Hart has said that “China should weaken its currency by more than 50 percent this year.”

If that were to happen, a tidal wave of Chinese money will rush into bitcoin. But the supply of bitcoin is tiny compared to China yuan deposits. Bitcoin will soar. Here’s what Hart said last February:

“buy bitcoin, because once the Chinese buying frenzy is unleashed, and $25 trillion in deposits scramble to be packed into a product with a $6.5 billion current market cap (but only when the price of a bitcoin is $430; the market cap does rise to $25 trillion if every bitcoin is worth $1.6 million) one thing will happen: the price of bitcoin will soar exponentially.”

Another prominent Wall Street figure who owns bitcoin is Michael Novogratz, co-chief investment officer of macro funds at the $55bn Fortress Investment Group. Before joining Fortress in 2002, he spent 11 years at Goldman Sachs, and he is a member of the New York Federal Reserve’s investment advisory committee on financial markets.

“Will more and more merchants allow you to buy stuff with Bitcoin? Novogratz asked rhetorically, at a conference in 2013, “We’ll see. My gut is yes, but you don’t need to know that to make a bet. There are enough libertarian…[anti] government guys to at least make this a bubble.”

So, an elite hedge fund manager who’s also an adviser to the New York Fed personally bought bitcoin, expecting an eventual bubble. That’s interesting.

Raoul Pal, another world-class investor, sees a possibility that bitcoin will take over “at least part of gold’s traditional role as a store of value.” One only needs to look at the recent Brexit vote and market anxiety to understand that he’s right. Gold began to rally in late May, about a month before the Brexit vote, as investors positioned themselves for uncertainty. Likewise, bitcoin began to rally about the same time, peaking about a week before the vote. Gold’s top appreciation through the period--13.5%. Bitcoins peak gain--68%.

In an interview with Grant Williams on Real Vision television in November of 2014, Pal, a former hedge-fund manager and founder of the Global Macro Investor, had this to say about bitcoin:

“I did some analysis a while ago, [It] was to try and create a valuation framework that gives some value to bitcoin because nobody really knows that it’s worth.”
“I said OK well let’s assume it’s something like gold — There’s a finite amount that’s been mined. The rest is underground. We kind of know how long it’s going to take before all the gold is mined or before all the bitcoins. Put them in the same kind of equation we get a value of bitcoin and that value is a million dollars. Now, you’ll never hear an analyst say this — but I don’t mind this — I could be wrong by 90%, and it’s still worth $100,000.”

Just a reminder--right now bitcoin is trading around $670.

An additional wild-card in the bitcoin story are potential bitcoin ETFs. The Winklevoss Twins, founders of Gemini Exchange, recently filed to become a bitcoin trust on the BATS exchange. SolidX, a blockchain tech firm, has also filed to launch an ETF on the NYSE. The products, if approved, will be a catalyst for institutional investment. And watch out when the Average Joe can buy BTC through his or her e-trade account.

So the ingredients are in place for the mother of all bubbles to inflate bitcoin. But as we know from John-Paul Rodrigue, there are four phases of a bubble. Currently we’re in the “awareness phase.” This is where the investment begins to attract widespread attention, and upward price momentum begins to accelerate. There can be several short-lived sell-offs as a few investors cash in their first profits. These pullbacks are the ideal time to enter before the upcoming blast-off.

The big money is made in a bubble’s “mania phase.” Here latecomers to the story discover the "investment opportunity of a lifetime" and chase prices higher. It’s when a feedback loop of rising prices, irrational exuberance, greed, leveraged bets and bullish news drives prices nearly straight up. Paper fortunes are made overnight.

Of course, the bubble sooner or later pops, and latecomers, along with those who linger too long at the party will see their capital disappear quicker than you can say “look out below.”

So be prepared. Accumulate a position in bitcoin. When the inevitable mania arrives, it will be fast and furious. But don’t get caught up in the bullish hysteria. Have a plan, strap yourself in, keep your eyes wide open, and be prepared for the ride of a lifetime.

 

 

Mark Gaffney