Cryptocurrencies not substitute for gold

Trade in gold is widely authorised and regulated in many markets unlike cryptocurrencies such as Bitcoin.

KUALA LUMPUR: Bitcoin and cryptocurrencies more generally are not a substitute for gold which is a tried and tested effective investment tool in portfolios, says the London-based World Gold Council.

In its recent report, the council sought to point out why gold is a better investment tool though its performance has not been so stellar versus the newer upstarts.

The council said gold has been a source of returns rivalling that of the stock market over various time horizons; it has performed well during periods of inflation; it has been a highly liquid, established market; and it has acted as an important portfolio diversifier, exemplifying negative correlation to the market during downturns. 

“Cryptocurrency’s performance has, until recently, been remarkable, but its purpose as an investment seems quite different from gold. Cryptocurrencies have yet to be tested in multiple markets. Since bitcoin’s inception, the stock market has been in an incredibly low volatility, trending, bull market, with very few pullbacks. 

“The crypto-market is young, and liquidity is scarce. Its price behaviour at this point, while still attractive to many investors, seems to be driven by high return expectations,” it said.

The council noted that Bitcoin’s parabolic price rise was the big story of 2017 – putting the spotlight on the cryptocurrency market. 

While gold’s performance was a solid 13%, it was a fraction of the 13-fold increase of bitcoin by the end of the year. 

“Some commentators went as far as to claim cryptocurrencies could replace gold. Cryptocurrencies may become an established part of the financial system. 

“But, in our view, gold is very different from cryptocurrencies, as gold: is less volatile; has a more liquid market; trades in an established regulatory framework; has a well understood role in an investment portfolio; has little overlap with cryptocurrencies on many sources of demand and supply.  

“These characteristics underpin gold’s role as a mainstream financial asset that will likely continue to resonate in today’s digital world,” it said.

When gold was used to back currencies, the gold price appreciated roughly at the rate of inflation. 

Since the collapse of Bretton Woods in the 1970s, gold has appreciated 10% per year, on average. 

The council pointed out while its price increased rapidly in the late 1970s, its price volatility has been relatively tame over the past four decades. 

Bitcoin, the most widely recognised cryptocurrency, has had rapid price growth over the past few years – increasing 13-fold in 2017 alone. Its price has also been extremely volatile – some 10 times that of the dollar denominated gold price. 

Bitcoin’s high volatility was evidenced by the sharp price correction it has experienced since mid-December 2017 – falling by more than 40% in a month. 

Bitcoin moves, on average, 5% each day, a level that is nearly as high as the realised volatility of the VIX itself.

While this is good for investors looking for extremely high investment returns, it is hardly a characteristic of a currency, let alone a store of value, potentially limiting bitcoin’s use as a transaction token.

Cryptocurrencies do not have a clear two-way market. Reports suggest their volume is driven by buy-and-hold investors, but, so far, they lack the characteristics common to most liquid markets with the ability to short large quantities. 

In addition, anecdotal evidence suggests there are high transaction costs for selling positions – both in monetary terms and in the time it takes for the transaction to settle.  

Despite the current size of the cryptocurrency market, which has been estimated to be valued at over US$800bil, volumes are very low compared to gold and other currencies. 

Bitcoin trades US$2bil, on average, a day, which is roughly equivalent to the world daily trading volume of gold-backed exchange-traded funds (ETFs). 

This volume, however, is less than 1% of the total gold market that trades approximately US$250bn a day. Gold demand is diverse 

Trade in gold is widely authorised and regulated in many markets. 

Cryptocurrencies are broadly permitted, in that most countries have deferred granting them approval, while not banning them – although there are a few outliers at both extremes – Japan appears to have granted approval, and China has greatly restricted their use. 

 “Some commentators have suggested bitcoin and other cryptocurrencies are at great risk of sudden restrictions from countries concerned about capital flight, investor protection, or loss of seigniorage,” it said. 

For example, South Korea, one of the world's largest cryptocurrency markets, has announced more regulatory measures. And in the UK, investors are facing hurdles to convert cryptocurrencies.