What’s happening in the cryptocurrency world is a great example of how markets function.
Many people are overwhelmed by bitcoin and the thousands of other tokens that have popped up. It’s not an easy market to get one’s head around. The terminology is alien, the security protocols are byzantine, and transacting is difficult in some coins. On the other hand, the percentage moves can be mouthwatering.
Over the years, there have been many comparisons between bitcoin and gold. Even though they’re very different asset classes, they certainly have some similarities. For example, both thrive on a limited-supply argument. Both have emotional followers who believe each asset represents the only true money. Most mainstream investors see them as fringe investments.
It’s one thing to understand the nitty-gritty of the market, but it’s quite another to observe how it trades. One of the biggest similarities between gold and bitcoin is in how they trade. That doesn’t mean they move together. It doesn’t mean they move the same amount, either. The similarity I’m looking at told me Ethereum – the world’s second-largest crypto by market cap – would break out soon after bitcoin and that Ripple – another crypto – would follow.
You see, the biggest similarity between precious metals and cryptocurrencies is they are relatively small and illiquid. That forces traders and investors to behave similarly regardless of which one they buy.
Gold broke out to new recovery highs in June 2019. The VanEck Vectors Gold Miners ETF (GDX) holds the larger, more established gold miners. It broke out of its base in April this year. Silver is often referred to as “poor man’s gold.” It broke out in July. The VanEck Vectors Junior Gold Miners ETF (GDXJ), which holds the smaller, less established gold miners, also broke out in July. The Global X Gold Explorers ETF (GOEX) has not broken out yet.
The sequence of events resembles a ladder of risk. People start out with the least risky bets while they are still cheap and migrate into riskier bets as prices rise. Investors began to worry about the size of the deficit and its effect on the dollar last year. The first asset they went to for security was gold, and the price rallied impressively. The higher the gold price went, the more enthusiastic traders became.
They started to look around at related assets that would do well from strong gold prices. Gold shares looked cheap, and many were offering nice dividends. They were a natural high-beta play on gold. As soon as they rallied, traders looked for the next catch-up candidate. That led them to silver and junior gold miners.
We are still in the early stages of this bull market because there hasn’t yet been enough appetite for risk to drive the explorers’ ETF out of its base.
Cryptocurrencies have much bigger moves than gold, but the ladder of risk is the same. Bitcoin broke successfully above $10,000 in July. Ethereum broke out of its base in August but has been very quiet until last week.
Based on what we saw with gold, the obvious trade was to bet Ethereum would continue to follow bitcoin higher. As soon as it did that on Friday, traders started looking for the next catch-up play in crypto. They landed on Ripple. The further bitcoin rallies, the farther up the ladder of risk traders will climb.
Over the weekend, news broke that PayPal and Cash App have bought up all of the new supply of bitcoin over the last month. PayPal has begun to allow its clients to transact bitcoin over its network. That’s allowing a whole new set of people to buy bitcoin for the first time. With all the new supply being hoovered up, the outlook remains bullish.
All the best,