Bitcoin and Gold Short-Lived Correlation Not a Sign of Comparability

The Bitcoin (BTC) and gold one-month correlation reached a record high of 68% as Bitcoin hit $12,000 early in August, but the correlation crashed by 20% the following week. Despite this, Bitcoin looks set to become digital gold in 2020 considering the price correlations and trends in the futures market.

Both gold and Bitcoin are having a phenomenal year in terms of year-to-date returns. According to Skew Analytics, gold has a 27.93% YTD return, while Bitcoin has racked up a 71.68% YTD yield. Although Bitcoin sees much higher volatility than gold, it seems that in these uncertain, pandemic-stricken times, investors are gravitating toward store-of-value assets such as gold and Bitcoin.

Same but different

Bitcoin and gold are very different assets in the traditional sense, which is mainly due to liquidity, owing to both being in different phases in their asset lifecycle. Gold currently has a market capitalization of about $9 trillion, whereas Bitcoin’s is only $228 billion.

These major differences aside, gold and Bitcoin are largely associated due to two similarities: both assets are “mined” and their scarcity entails an inelastic supply. The latter means that no matter how much the price of the asset increases, supply cannot increase due to production limitations. Commodities with an elastic supply would not be scarce, and thus cannot be considered a store of value. Dan Koehler, liquidity manager at crypto exchange OkCoin told Cointelegraph: “While any asset can have value based on supply and demand, limited availability in gold and BTC give them a unique blueprint as a store of value.”

Even though gold is an asset that is considered to be a store of value, in terms of usage, it has a few applications in the electronics and jewelry industries, and is predominantly used by governments and central banks as a value holder for fiat currency, while Bitcoin is purely used as a store of value for investors.

Koehler also pointed to Bitcoin’s volatility being detrimental to the title of “digital gold” as it looks to become a safety asset: “Bitcoin has fought to hold this title as well, but its periods of high volatility in the past has prevented it from capturing more market share for this title.” Dennis Vinokourov, the head of research at BeQuant — a crypto exchange and institutional brokerage provider — told Cointelegraph that Bitcoin maximalists admire deflationary assets, adding, “Given the safe haven and inflation hedge status that gold holds, it is probably the only other asset that somewhat resembles what Bitcoin native stand for.”

While correlations are often used to compare two assets in the financial markets, Vinokourov further warns investors to focus on Bitcoin’s diversification instead of relying too much on correlation values over various time frames:

“While the 1-month correlation between the two has risen lately all the way to 68%, the much more widely used 3-month measure stands at a mere 15%, while longer duration such as 1-year, the correlation coefficient is even lower. As such, caution is warranted when building investment thesis based on the above metrics and instead, it may be better to focus on Bitcoin’s diversification capabilities instead.”

It is important to note that over longer durations, Bitcoin is largely uncorrelated with all the major assets available to investors. The correlation with traditional assets is usually between 0.5 and -0.5, suggesting that the relationship between their returns is extremely weak.

When looking at correlation figures, it is critical to keep in mind that the two assets ultimately represent separate markets that have different macro and micro economic factors affecting each of them. Koehler furthered this voice of caution by stating:

“It’s important to remember that historical correlation merely looks to show how two markets have moved together or disjointed, but is not an explanation of such movements. [..] News in one asset (a BTC hard fork for example) doesn’t necessarily have any effect on the Gold market and as such BTC volatility around that event may not be reflected nearly as much in the Gold market and correlations may decrease as the asset’s returns deviate.”

For example, the all-time high in Bitcoin and gold correlation was seen at the same time when Microstrategy, the world’s largest business intelligence firm, bought $250 million in Bitcoin, making the asset its primary treasury reserve. This is seen as a major sign of institutional interest. Marie Tatibouet, chief marketing officer of Gate IO — a cryptocurrency based in Virginia — told Cointelegraph that this signals a huge validation, adding:

“During Q1 and Q2, the correlation has been rising, reaching prominent peaks, close to 50% and 60%, since the coronavirus outbreak. In these times of uncertainty during the pandemic, with significant inflation hovering over the world, people are looking for a safe-haven asset.”

Correlation to other markers

In addition to being correlated to gold, Bitcoin is often compared with the Standard & Poor’s 500 Index, the United States dollar and even the VIX volatility index. Yet, in spite of oil being the highest-traded commodity on the market, no correlations can be drawn between West Texas Intermediate and BTC.

This is due to the high supply of oil and it being considered a bountiful, inexpensive resource. This was demonstrated recently during the pandemic, when oil prices dropped to negative and investors were being paid just to store the oil. Tatibouet elaborated on why the S&P 500 is often used as a benchmark for price correlation with Bitcoin:

“The correlation between the coin and the S&P has been more significant throughout the years than between the digital asset and gold. At the same time, gold and BTC seem to have a more parallel relationship, but BTC–S&P 500 interaction happens differently, which moves more cyclically most of the time. When BTC price drops, the correlation with the stock market index grows, and as BTC price bounces back, their correlation diminishes.”

In both long- and short-term correlation metrics, Bitcoin seems to have a higher correlation with the S&P 500 index than gold, with a one-year correlation of 0.36, while gold’s is at 0.08.

Bitcoin perceived as more risky

In comparison to gold, Bitcoin is often perceived to be more risky due to its higher volatility, lesser liquidity and lower levels of adoption by governments and institutions in comparison to gold, which has been one of the most highly commoditized assets in the markets historically. Vinokourov elaborated on Bitcoin’s price volatility in relation to risk:

“Bitcoin’s propensity to undergo parabolic price runs, as well as flash crashes for that matter, is a bigger risk to its perceived notion of being a store of value asset than price volatility. After all, it is said that volatility is an inverse gauge of liquidity. [...] Any asset can be subjected to excessive volatility, it is how market participants, including the liquidity providers react to price discovery vacuums and other risks that ultimately matters.”

Agreeing that gold is historically the more stable asset, Tatibouet elaborated that “when it comes to hedging, BTC is more effective in the short term, especially against the agitated markets.” In addition, she pointed out that “gold’s returns are lower than Bitcoin ones, making the digital gold a lot more attractive despite its risky aspects.”

In the current bull run that has taken Bitcoin into the $12,300 range, several traditional assets and commodities could establish price relationships with Bitcoin. However, investors would need to be wary of macro economic events impacting these correlations.