This Factor Provides The Best Clues To Future Price Direction
It has long been our contention that all markets are interconnected. The popularity of Bitcoin and other cryptocurrencies, and their extreme volatility, therefore, deserve the attention of all investors for their potential to influence other markets.
I must confess to struggling with cryptos, whether by virtue of my age (well over 21) and/or my experience. The concept of a currency not backed by any government, whose value depends on the ability to find a buyer willing to pay an arbitrary price, reminds me more of the 17th tulip bulb mania than anything else. There is literally zero underlying economic value for any of the cryptocurrencies, which means their prices depend purely on buyer sentiment, which can be fickle.
That is not to say that Bitcoin et al. will plummet to zero anytime soon. Some very intelligent people espouse that the current price of Bitcoin is but a fraction of what it will be in a couple of years and that cryptocurrencies are destined to sweep away the existing system of currencies.
That may be true, but I strongly doubt it. The weight of evidence seems to argue against the bullish case for the long term. I remind readers that very bright people can be very wrong. A famous example is Isaac Newton (inventor of physics, calculus, and general bright light), who lost most of his wealth late in life investing in the South Sea bubble.
The chart above suggests that while the recent decline in the Bitcoin price has been steep, it has not represented unprecedented price action over the past five years.
Where does the price go from here? The lack of intrinsic value means the price is 100% a function of investor sentiment.
The challenges to maintaining sufficient investor optimism to support prices are mounting.
To my mind, the fatal flaw of cryptos has always been the likelihood of action by governments against them should they display conspicuous popularity. No government can be reasonably expected to surrender control of its economy by losing control of the currency. Thus, most central banks are developing their digital currencies. Moreover, many governments have moved to make disclosure and taxation of cryptocurrency holdings mandatory, robbing these digital currencies of their “crypto” feature.
The volatility of Bitcoin et al. makes them unsuitable for business transactions, where a measure of price certainty is desired. Even Elon Musk had to bow to this economic reality by reversing his decision to allow the purchase of Tesla in Bitcoin.
Bitcoin is also facing increasing scrutiny from those who are sensitive to environmental matters. The “mining’ of Bitcoin requires enormous amounts of electricity to power computers. Many of these computers reside in China, where the dominance of fossil fuel-based power generation is a major global environmental concern.
It is likely not a coincidence that the popularity of Bitcoin and other digital currencies has occurred during a time of remarkable investor optimism and complacency. Investor optimism was briefly shaken by the market decline in early 2020 but rebounded stronger than ever in response to the unprecedented economic support supplied by central banks and governments.
An obvious inference (at least to me) is that the reliance of Bitcoin’s price on investor sentiment ties its fortunes to the same forces that drive stock markets. If so, the marked recent weakness of Bitcoin may suggest that air is leaking from the “irrational exuberance” balloon, which could portend more significant weakness by markets.
Investors in stocks can take comfort in the proviso that the inherent tangible value of the companies will provide a floor to a decline. Bitcoin et al. have no such “floor.”
It is the lack of intrinsic value and almost certain government action against them that has prevented me from playing the crypto game.
Therefore, we will not be “buying the-dip” during the current decline of Bitcoin. There is no suitable purchase price in the absence of some credible estimate of an asset’s economic value.
Should Bitcoin subsequently rally to infinity, we will be happy for those invested but not unhappy with our decision. Bitcoin et al. simply do not meet our risk/reward criteria. We are concerned about earning a superior return on investments that reflect our methodology. We long ago recognized that FOMO (fear of missing out) is a highly destructive emotion for investors.
It will be surprising if the volatility being seen in cryptocurrencies does not spill over to other markets, which is why their behaviour should be monitored by all investors, not just those directly invested.
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