2020 brought the COVID-19 pandemic, and everything in the world changed dramatically. The world’s economies entered recession, and governments and central banks intervene by easing both the fiscal and the monetary policies.
As such, inflation expectations rose around the globe. Prior to the pandemic, most central banks in the developed world had a hard time fulfilling their mandate of price stability. But now, the risk is that inflation will overshoot targets globally, which is why investors should turn to the monetary inflation hedge – the gold market.
Yet, the price of gold declined significantly since its all-time high in 2020. After briefly trading above $2,000 in August 2020, the price of gold retreated below $1,700, where it found some support.
Why is the price of gold declining if inflation is poised to rise in the months ahead?
The New Gold
One reason is the new gold – Bitcoin. Cryptocurrencies had a tremendous reaction to the pandemic, as investors flocked into digital assets like there is no tomorrow. According to Coinbase, a cryptocurrency exchange, the number of traders increased dramatically in the first quarter of the new year, explaining the rise in prices.
Bitcoin traded above $60,000 over the weekend, but less than six months ago, it was below $10,000. In other words, while gold declined from above $2,000 to $1,700, Bitcoin rose to over $60,000. The trend accelerated since Tesla announced a $1.5 billion investment in the “new gold” at the start of the year, and so its share price strongly correlates to the price of Bitcoin.
Market Bouncing from Strong Support
The move higher in Bitcoin and lower in gold is a divergence difficult to understand by traders. After all, if inflation is supposed to pick up, but the price of gold declines, it means that investors have found a new way to protect their portfolios from it. Effectively, it means that Bitcoin serves as a hedge against inflation, and funds flow out of the gold market.
The problem here is the extended rally in Bitcoin. If, indeed, investors look for protection against inflation by buying Bitcoin, the current levels suggest much higher inflation than anticipated. We will find out tomorrow when the U.S. inflation is due, if there is a link between the two. If inflation exceeds expectations, Bitcoin, and not gold, will benefit from it.