How The Bitcoin Boom Can Boost The Gold Price

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Includes: BTC-USD, BTCS, COIN, GBTC, GLD, PHYS
by: Geoffrey Caveney
Summary

The cryptocurrency boom means that gold is incredibly cheap now when priced in terms of bitcoin.

Savvy early cryptocurrency investors may now be taking some of their enormous profits and investing part of the money in gold.

So this year's huge cryptocurrency profits may actually be a potent new source of added demand for gold. This may partially explain the bullish gold price movement this week.

The total cryptocurrency market cap is now over $175 billion. If just 2% of it were invested in gold, it would be 10% of the GLD market cap or 6%-9% of daily CME COMEX gold futures volume.

Bottom line: New gold demand from new cryptocurrency millionaires and billionaires may provide a new tailwind to boost the gold price.

When I wrote my article this week, "Priced In Yen, Gold Is Now Above Its 2016 High", users Alpha Man and Baidewei made the comment, "How is gold doing priced in bitcoin?"

They meant this as a joke, but in this article I will seriously discuss possible connections between the prices of gold and bitcoin.

Of course the simple answer to the user comment is this: Priced in bitcoin, gold is now absurdly cheap, cheaper than ever, simply because the bitcoin price has soared so astronomically higher this year.

At the beginning of 2017, and until late March, the bitcoin price was still around $1,000. It took more than 1 bitcoin to buy an ounce of gold. In late April, the bitcoin price surpassed the gold price for the first time ever, and one could buy an ounce of gold for less than 1 bitcoin.

As of today, one can now buy an ounce of gold for less than 0.30 of a bitcoin. Like I said, priced in bitcoin, gold is now absurdly cheap.

At first this may seem like a silly comparison, like talking about the value of gold priced in Dutch tulip bulbs in the 1600s or gold priced in shares of dot-com stocks in 1999-2000. But bitcoin is a little bit different, because unlike tulip bulbs or dot-com stocks, bitcoin is intended to function as a currency.

So it is actually not quite so absurd as it may seem to speak of currency exchange rates between bitcoin and gold. In fact, many global currency exchange rate websites now list both gold and bitcoin among the currencies whose exchange rates may be calculated. Here is xe.com's 1-year chart of the gold/bitcoin rate that I have described:

(Source: xe.com)

But seriously, what is the real world meaning of all these rates?

The Significance Of Gold At 0.30 Of A Bitcoin

The significance of the low gold/bitcoin rate is this:

Right now, it is likely that many savvy bitcoin and digital currency investors are taking a chunk of their newly made millions in bitcoin/cryptocurrency profits, and buying some gold with the money.

Think about it: If you had just become a multi-millionaire out of nowhere in the cryptocurrency boom this year, surely you would take some profits and diversify your wealth in various holdings in different asset classes, right? It makes perfect sense to think that many of 2017's new crypto-millionaires (and billionaires?) are buying a decent amount of gold with their profits, in order to diversify among very different types of safe havens -- especially right now when gold is so incredibly cheap compared to bitcoin.

Bitcoin investors and traders probably know more about the value of gold than most investors do, since the concept of bitcoin was directly modeled on that of gold in the first place. Rather than turning up their nose at gold entirely as an outdated relic, the smart ones among them are wisely buying some gold now as a back-up safe haven for the times when they may not be able to access their digital currency safe haven holdings. (Example: losing cellular service in a natural disaster such as Hurricane Harvey or Typhoon Hato.)

I have suggested to gold and precious metal investors -- in articles about bitcoin, ethereum, and litecoin -- that they consider diversifying their safe haven holdings with just a little slice of digital currencies: If you hold 5%-10% gold, it seems wise to also own 1%-2% bitcoin/ethereum as a back-up.

But these young bitcoin and crypto-millionaires may be doing the same thing, in reverse: They start by building up much of their wealth in digital currencies, and then they diversify by buying a little slice of gold and precious metals as a back-up! To each his own. It may seem like a backward approach to those of us who see gold with 6,000 years of history behind it vs. bitcoin with 6 years of history behind it, but from the perspective of these Millennial investors, it may make good sense.

China, Russia, Bitcoin, And Gold

And I have one more nugget for people to consider. This can only be speculation, but I have to think, wouldn't you expect that the Chinese government has probably been wise enough to make a certain amount of bitcoin and other digital currency investments over the past several years? We all know that bitcoin and digital currencies are very popular in Asia, much more so than in the West in fact. Surely the Chinese government had the foresight to make some strategic bitcoin investments several years ago, wouldn't you think?

We also know that China has a strategic interest in ramping up its gold reserves. This is no secret, even if the exact amount of China's gold holdings is. Jim Rickards and others have written extensively about China's gold reserves buildup in recent years.

Given all of this, now looks like the perfect time for the Chinese government to be taking some very big profits on its bitcoin and digital currency investments, and using the proceeds to buy gold to add to its strategic reserves, at a moment when the price of gold compared to bitcoin is incredibly cheap. It's quite simply a good bit of business.

Of course it is not possible to point to any concrete evidence that this is happening -- it is simply a plausible possibility based on a general understanding of China's interests and the strategic financial actions that they may be likely to have undertaken in the past and to be undertaking in the present.

We may make the same observations about the Russian government: They have certainly been interested in and knowledgeable about bitcoin and digital currencies for quite some time, it makes sense that they could have made such strategic investments several years ago, they may be wisely taking some profits on them in 2017, and we know they have a great interest in building up Russia's gold reserves. All of this means that it also makes perfect sense for Russia to use some of their cryptocurrency profits to buy more gold right now, when the price of gold relative to bitcoin has never been better.

Bottom Line: Bitcoin Profits Are A Source Of New Demand For Gold

The bottom line is this: All of the bitcoin and cryptocurrency profits that have been pouring in this year may be a potent new source of added demand for gold, as many investors use a part of those profits to buy gold while it is cheap compared to bitcoin.

I believe this dynamic may be one factor behind the surprisingly strong bullish performance of the gold price this past week. The financial headlines about the rising gold price continue to refer to geopolitical tensions and North Korea, but in fact the gold price has stayed high and kept rising even later in the week, when the immediate North Korea concerns had died down and global stock markets had rallied again. North Korea as an explanation for the gold price doesn't hold up to careful examination and simply doesn't make sense.

Simply put, global investor demand for gold has continued to grow by a sufficient enough amount to keep the gold price well over $1,300 per ounce this week, despite the lack of particular apparent geopolitical or macroeconomic causes for it. What truly matters is not the reasons for the demand, but rather the amount of the demand.

And the amount of the global demand for gold has been boosted, I believe, by large numbers of global investors cashing in some of their massive bitcoin and cryptocurrency profits and buying some gold with the money.

Below are two charts: The first is a chart of the bitcoin price from this May to now, the period of the really big bitcoin boom. The second is a chart of the gold price during the same period. You will see that although the magnitude of the bitcoin price movement is of course much greater, the directions and the trends of the bitcoin and gold price movements are similar.

(Source: xe.com)

Some of the similarity is just because both bitcoin and gold can function as safe haven assets. However, as I pointed out above, the gold price action over the past several days of this week cannot be very well explained as a safe haven trade, since the gold price and stock prices have been rising at the same time.

Rather, I think some of the correlation seen in the charts above is due to massive bitcoin and cryptocurrency profits being partially reinvested in gold.

Size of the Cryptocurrency and Gold Markets

Is the cryptocurrency market large enough compared to the gold market, that the amount of profits made on crypto could be substantial enough to have a meaningful effect on the gold market if they are being reinvested there? I believe so.

With the massive growth of bitcoin and all digital currencies this spring and summer, the total cryptocurrency market cap is now over $175 billion. For perspective on the size and speed of its growth this year, keep in mind that it was only around $25 billion as recently as this March, and it did not even break above $30 billion until late April. The following chart from cryptolization.com illustrates the enormity of the trend vividly:

(Source: cryptolization.com)

(In fact, we may observe that the ups and downs of this chart since May parallel the gold price even more closely than the bitcoin price chart does.)

By comparison, the recent average daily volume of COMEX gold futures on the CME exchange has been about 300,000 to 450,000 contracts:

(Source: cmegroup.com)

Each contract is 100 ounces of gold, so the daily volume amounts to about $40 to $60 billion.

Further, the total market cap of the popular SPDR Gold Trust ETF (NYSEARCA:GLD) is about $35 billion.

So we can see that the total cryptocurrency market is now large enough that if, for example, 2% of its total market cap ($3.5 billion) were invested in the gold market, that would constitute 10% of the GLD market cap or 6%-9% of the daily volume of the CME COMEX gold futures market. Yes, it would be enough to move the gold market.

I believe a dynamic along these lines partially explains the gold price movement this week, including the increase in daily volume of gold futures this week that you see in the chart above.

Summary

To sum it all up in one bullet point:

  • New gold demand from new cryptocurrency millionaires and billionaires may now be providing a new tailwind to boost the gold price.

Note: If you want to buy some bitcoin/ethereum/litecoin, you can set up an account on Coinbase the same way you do with your standard brokerage account. Also, if you choose to use this link and you buy at least $100 worth of bitcoin/ethereum/litecoin, you and I will both get $10 worth of bitcoin free. Hey, every little bitcoin helps!

Disclosure: I am/we are long PHYS.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am long bitcoin, ethereum, and litecoin.

Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.