The cryptocurrency market is a relatively new one when compared to the traditional precious metals market. Can we talk about Bitcoin and gold as complementary assets, given their low correlation?
Gold and Bitcoin are viewed by many as assets that offer diversification benefits to the trading account. Gold has been traditionally viewed as a hedge against inflation, while Bitcoin, the “digital gold”, has been adopted by more and more institutional investors lately.
The bullish trend in the price of Bitcoin, which started with MicroStrategy and Square’s announcement of making an investment, continued with Tesla’s $1.5 billion commitment to Bitcoin. Since then, Coinbase, the largest cryptocurrency exchange, became a public company, and the interest of the retail community in digital assets increased exponentially.
Yet, gold and Bitcoin do not act as correlated assets. In fact, they have little or no correlation, countering the argument that an investor must choose gold or Bitcoin to diversify the portfolio.
How about choosing both gold and Bitcoin?
Bitcoin to Replace Gold as a Store of Value?
To do so, Bitcoin should not have such big daily fluctuations as it has. For example, a couple of days after Elon Musk, the CEO of Tesla, announced that the company would not accept Bitcoin as payment for purchasing cars, Bitcoin declined over 20%. Fast forward a couple of weeks, and the digital asset lost more than half of its value, dropping from $64k to $32k.
Gold, on the other hand, is not that volatile. Can it be that a gold and Bitcoin combination would bring advantages to the long-term investor? Here are some arguments in favour.
Firstly, gold and Bitcoin are uncorrelated assets, thus leading to improved risk/return characteristics and to an asymmetric payoff profile, or to positively-skewed returns.
Secondly, Bitcoin’s volatility can be used to the investor’s advantage by using options strategies to lower the volatility.
Thirdly, when added to a portfolio, the combination of gold and Bitcoin as a strategic allocation should favor gold more than Bitcoin. For instance, traditionally, institutional investors chose to allocate 5% of their long-term portfolio to gold. In such a scenario, the 5% should be split between two parts gold and one part Bitcoin. This way, the investor stands to benefit the most from Bitcoin’s volatility and gold’s ability to act as a store of value.
All in all, the combination of the two assets is particularly interesting given the lack of correlation between the two. As long as the two act as complementary assets, investors stand to obtain further diversification benefits by combining them.