How Uncorrelated Is Bitcoin?

Summary

• Bitcoin decoupled from other risk assets following its September 29 price action.
• After a period of relatively high correlation to U.S. equities, this is a reassuring sign in the debate that Bitcoin is truly an uncorrelated asset.
• More importantly, Bitcoin’s correlation with inflation expectations may signify its adoption as an inflation hedge over gold.

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According to Bridgewater’s Ray Dalio, “diversifying well is the most important thing you need to do in order to invest well.” His “Holy Grail” of diversification is fifteen uncorrelated bets. Can Bitcoin (BTC-USD) play a role as one of these uncorrelated bets in a diversified portfolio? This article explores the subject.

The long-term data says, yes. The recent decoupling is a constructive data point given an era of relatively high correlation between Bitcoin and U.S. equities since 2020. Some investors remain unconvinced and believe that the four-year cycle narrative will give way to Bitcoin becoming just another risk asset. In truth, Bitcoin is still on the four-year price cycle path. Additionally, it has a higher correlation with inflation expectations than traditional financial assets, lending credence to the digital gold narrative.

The Data

A 2020 report from Fidelity Investments studied Bitcoin’s correlation with other risk assets from 2015-2020. The result? The long-term, rolling 30-day correlation between U.S. equities and Bitcoin is 0.15 on a scale from -1 to 1. The correlation between High Yield Credit and Bitcoin is closer to zero at 0.05. For reference, REITs had a .77 correlation with U.S. equities and High Yield Credit had a 0.53 correlation with U.S. equities.

The idea of false diversification is a real risk in markets given the study. Financial assets rise and fall in tandem due to investor appetite during periods of risk-on and risk-off, and investor appetite has remained elevated due to structurally dovish Fed policy acting as a tailwind. Bitcoin’s long-term non-correlation from the Fidelity study supports Dalio’s idea that Bitcoin is uncorrelated to traditional financial assets and has a place in every portfolio.

Despite this, Bitcoin underwent an era of relatively high correlation since 2020. Bitcoin’s average annual correlation for 2020 was 0.22 and reached 0.5 in September 2021. Many pundits, including very early Bitcoiners, posited that Bitcoin’s correlation with traditional financial assets would increase as its market capitalization increased. In essence, Bitcoin would trade on dynamics such as global liquidity and growth and not its four-year price cycle once institutional money became involved.

Therefore, Bitcoin’s recent break from gold, the S&P 500, and the 10Y treasury note is a reassuring data point for investors who advertise Bitcoin as a portfolio diversifier. The chart below shows the magnitude of the break. Bitcoin has exploded 32% versus the S&P 500’s 1.6% since September 29. Bitcoin’s four-year cycle framework seems intact.

(Source: Author; Tradingview.com)

Bitcoin the Inflation Hedge

The charts below of Bitcoin’s price and 5-year forward inflation expectations show similar patterns. Each topped in May and chopped sideways since. They also have a current correlation of 0.6, which is much higher than even the highest correlation between Bitcoin and U.S. equities in two years. Perhaps Paul Tudor Jones was correct in thinking of Bitcoin in terms of inflation hedging. This makes intuitive sense given that any scarce asset will outperform in times of inflation and Bitcoin is the only perfectly scarce financial asset to exist.

(Source: FRED economic data)

Gold is underperforming in a macro environment that has historically led to strong returns. Uncharacteristically, base metals are surging while gold remains left behind as shown below. The extent of which is difficult to determine, but I believe Bitcoin is stealing market capitalization from gold. I came to this realization long ago and wrote about it extensively in my recent book. One typically buys Bitcoin and gold for the same reasons. It is a scarce store of value in an era of unprecedented Fed balance sheet expansion. However, when Bitcoin outperforms gold by 200% annually, I question the need to own both, especially when much of the regulatory uncertainty is being assuaged to the upside.

(Source: Author; Tradingview.com)

Additionally, Bitcoin perfects the qualities that made gold desirable in the first place while addressing its limitations. Bitcoin is perfectly scarce, almost infinitely divisible, and frictionlessly transported and stored. I was a global macro investor and gold investor before I studied Bitcoin. My conclusion is that current gold bugs are racing a horse and buggy against a Lamborghini. Though gold will surely hold more value during risk-off moments in markets, decades of underperformance make a few months of outperformance irrelevant.

Conclusion

In the debate of Bitcoin's true correlation to other financial assets, several facts come to light. Firstly, Bitcoin is historically an uncorrelated asset. Though the high correlation to U.S. equities of the past year and a half worried some Bitcoiners, the recent decoupling shows that Bitcoin still moves according to its four-year cycles. The cycle framework may one day break as Bitcoin becomes more institutionalized and trades solely according to growth and inflation metrics, but I believe that is several years away if it even occurs. For now, Bitcoin fits the criteria of an uncorrelated bet. George Soros is only the most recent investor to publicly recognize this.

Additionally, studying Bitcoin in relation to other assets misses the correlation between the asset and inflation expectations, fulfilling the promise of the digital gold characterization. Gold investors will surely disagree with that statement, but performance does not lie. Gold has flatlined compared to Bitcoin on any long-term chart. We are in an era of unprecedented monetary and fiscal expansion, with the Fed purchasing $120 billion of bonds per month through its QE programs. Bitcoin was made for this.

Disclosure: I/we have a beneficial long position in the shares of BTC-USD either through stock ownership, options, or other derivatives. 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.