Reading  Ranjeetha Pakiam’s recent article in Bloomberg demonstrates some very significant money flows, finding reason to move into Bitcoin. While acknowledging that Gold is a good hedge against inflation, and possible declines in the dollar currency, the author and investor sees Bitcoin as a potential better performer and as such he has invested significantly in Bitcoin.

A few comments might be in order.  

Some mangers looking to hedge inflation select a mix of assets that perform well when inflation rises. Energy, Oil, Gold and Bitcoin or low-inflation-rate country currencies can create a basket of performance — capturing whatever moves as a correlated asset to inflation. Even a short position in fixed income can reflect rising inflation expectations. 

The US dollar as a currency value relative to other currencies can be hedged using Bitcoin since the digital currency here is limited, while the dollar drops as interest rates decline. But I would be cautious about a dollar decline going forward. In fact, rising interest rates support the dollar as a currency since capital flows come back to the dollar-based market. As the Fed raises interest rates, money will come to the USA attracted by better interest income.  We have already priced in the low interest rate environment and are proceeding to price in higher rates in the future, as reflected in a steepening yield curve.

Lastly, as mentioned in my earlier article, there is significant volatility in Bitcoin’s pricing. This far outweighs  the expected movement towards higher inflation. Treasury Secretary Yellen, I believe, has mentioned an expectation of a 3% inflation rate. That is a move of 1% from recent inflation. A hedge that moves up to cover that inflation move does not require a huge move to offset the inflation movement. Bitcoin price moves are much more volatile than a hedge needs to be. A move higher in inflation of 1% is dwarfed by Bitcoin’s moves. In fact, using Bitcoin as a hedge actually raises risk to your portfolio.  How can one have a position that is that radical as a hedge?

Lastly, are the markets well-priced for expected inflation already?  It’s hard to say since asset prices have rallied so much due to the lavish easing that comes from the Fed, even now. The markets are in some ways prepared already, and so is the dollar. But they are not fully prepared since cash still has no interest or return and has  to be invested to earn some better return than zero. So, the market is ahead of the Fed with some uptick in interest rates. Or is the Fed late and has fostered over-investing?

So, if inflation rises a percent or two, will your hedges work? What if the market has already prepared itself for the change in Fed policy due to inflation? In that case, hedges can actually perform poorly and may prove expensive.   And if the Fed leaves short term rates alone in their policy shift, there is still plenty of money in the system, limiting the market reaction to the policy shift. The market will have to absorb the supply of bonds the Fed no longer purchases, but again, there is plenty of cash to do so. And so, the market may not have a big move reducing the effectiveness of your hedges as hoped.

Below is an excerpt from the article which originally appeared in Bloomberg.

Gold Is Good But Bitcoin Better for $7.5 Billion Hedge Fund

By Ranjeetha Pakiam

June 6, 2021, 5:00 PM EDTUpdated on June 7, 2021, 5:20 AM EDT

  • Buillion still expected to hit record amid debt-level concern
  • Both assets well-placed to withstand Fed taper, SkyBridge says

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Gold will surge to fresh highs in the next year, but investors seeking currency alternatives as global debt balloons should look to Bitcoin, according to a $7.5 billion hedge fund.

Both are likely to rally even as the Federal Reserve moves to taper asset purchases, said Troy Gayeski, co-chief investment officer and senior portfolio manager at SkyBridge Capital. The two are frequently compared by investors, with former Treasury Secretary Lawrence Summers saying cryptocurrencies could stay a feature of global markets as something akin to digital gold.

“We’re going to stick to Bitcoin and crypto because we just think there’s more upside,” Gayeski said in a telephone interview last week. While there’s more volatility, “you’re going to capture a little bit more juice than you will in gold from that same phenomenon,” he added. The company’s Bitcoin fund is up 51.2% since its inception in late December through to June 1.

Investors are tracking commentary by the U.S. central bank as inflation ticks higher and policy makers move closer to paring the huge asset purchases that rescued the economy from the turmoil caused by the pandemic. The monetary support has driven the Fed’s balance sheet to a record, while muscular fiscal spending has boosted government debt. Both may pose an eventual risk to the dollar’s value, potentially burnishing the appeal of alternatives.

“All fiat-currency alternatives — which have all gone through fairly recent substantial corrections — are in a much better place now to handle that eventual taper and gradual slowing of money-supply growth, than they were as they were making higher-highs after higher-highs,” Gayeski said.

Both Bitcoin and gold have seen substantial swings this year, which unfolded amid a debate about whether the cryptocurrency was drawing demand away from bullion. The digital token soared to a record near $65,000 in April, before plunging. It was last around $36,200. Gold, meanwhile, came close to sinking into a bear market in March, but reversed course to erase year-to-date losses.

Leading Wall Street banks are divided on the relative merits of the pair — Citigroup Inc. has said gold is “losing luster” to cryptocurrencies, while Goldman Sachs Group Inc. made the case that the two assets can coexist. Tesla Inc. boss Elon Musk, whose tweets have roiled Bitcoin prices this year, said in May he supports cryptocurrencies over fiat, or paper, currencies.

Bullion, which hit a record above $2,075 an ounce last year, has now established a floor, according to Gayeski. A lot of the taper talk concerns have been pulled out of the market, and even when it’s announced, the Fed is not going to start reducing the pace of its purchases until 2022, he said.

“Going forward, the probability of gold continuing an uptrend is fairly high, making new highs over the next year,” he said