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bitcoin decouples from gold
bitcoin and gold have similar inflation hedging narratives. Gold currently has a lower inflation rate (1.7%) than bitcoin (1.8%), but it will be a monumental turnaround by halving. A simplistic inflation story would require gold and bitcoin to rise together. However, gold is taking a beating in recent days while bitcoin rebounds.
Very recently, bitcoin has been trending higher as gold has plummeted. They are disengaging over the last week in a very obvious way. We might expect gold to lag bitcoin during moves, but this is in exactly the opposite direction. Gold plummets while bitcoin rebounds.
In fact, we see a slight inverse relationship with the CPI of gold and bitcoin. Last year, when the CPI was soaring, gold and bitcoin sold off. Some have arbitrarily argued about the timing, saying that bitcoin was pumped before the CPI spiked. Or maybe inflation is not the main force in this market.
Chinese selling gold
We have something to explain this contradiction between the fall of gold and the rebound of bitcoin. The Chinese are likely selling gold, rather than dollars, as a way to protect their currency and preserve their precious dollar foreign exchange reserves. I came across this article from Mining.com, China gold prices plummet the most since 2020, halting record premiumwhich claimed that a Chinese Communist Party quota on gold imports had just been eliminated to “reduce the need for local banks to buy dollars.”
This is a surprising development and explains what we are seeing on the gold chart above. The Chinese are in a devastating dollar shortage and credit crisis. I repeat, a shortage of dollars, not an avalanche of liquidity and money printing. It’s time to bury the inflation narrative.
The correlation of both gold and bitcoin with the CNY is surprising.
Please note, Chinese the markets are closed this week for the Mid-Autumn Festival and China’s National Day (September 29 to October 8). The CNY data above comes from the Intercontinental Exchange (ICE), but other sources do not show the recent increase. There was a higher low in the CNY before the market close for the holidays, and I was expecting an imminent overall market reversal/consolidation. This would fit both bills.
Other evidence supporting this CNY bounce is seen in bitcoin. It has also been highly correlated with the CNY, and this week’s bounce likely corresponds to a CNY bounce in the parallel markets.
Using gold instead of Treasuries and foreign exchange reserves to support the yuan’s slide is a smart move and would remove selling pressure from U.S. Treasuries. This could turn the tide on the runaway US 10-year bond yield, which hit 4.82% on Tuesday. The same thing happened from September to October, when the 10-year bond shot up from about 100 basis points (bps), from 3% to 4%.
The predominant pressure in this market is a shortage of dollars, not inflation. The dollar shortage, higher rates, and higher oil prices we have discussed above will push the market into recession. Even a brief easing of pressure on the yuan by selling gold could create a disproportionate move in bitcoin. bitcoin rallied 40% in January and March, and 26% in June thanks to similar or weaker yuan moves. bitcoin only needs to rally 17% currently to break the long-term resistance at $31,000.
Market-based inflation expectations
Returning to the US markets, regarding inflation versus recession probabilities. Last week, I wrote extensively about this relationship. If a recession is around the corner, something markets are pricing in federal funds futures and many experts agree, that scenario rules out even mild inflation. It’s one thing or another. Either inflation or recession.
Using that heuristic, we can examine inflation expectations and apply them to recession probabilities.
The most respected market indicators for headline inflation expectations are the 5-5 year forward contract (expected inflation for the 5-year period starting in 5 years) and the 5- and 10-year breakeven points (the difference between inflation-protected securities (TIPS) and securities not protected at those maturities).
The three measures show that the market expects inflation of less than 2.5%. Red arrows indicate reversal moments, that is, moments when the 5-year breakeven point was above the 10-year breakeven point. This is another inversion similar to the yield curve, which indicates recession.
There is also a pattern in the compression of spreads. Before the Great Financial Crisis and before COVID, when recession became more likely, spreads tightened. Today we see compression again with only 24 bps separating the three.
Inflation expectations of 2.5% are neither high nor low, so it is difficult to draw a direct conclusion from the level itself. However, the tightness indicates that the market is increasingly worried, as in 2007 and 2019. The next thing we should expect is for inflation expectations to start to decline as we approach recession.
We can compare a forecast of falling inflation expectations with the level of bank credit. After all, that’s base money in a credit-based system. If inflation were a threat, bank credit would have to be increasing, making recession impossible. However, we see quite the opposite. The year-on-year change in bank credit has reached zero.
Bank credit is stagnant, meaning a deflationary outcome is very likely. That’s great for bitcoin, because it’s also a hedge against systemic credit risk. There is no counterparty risk for your bitcoin, unlike all types of credit-based financial assets.
Therefore, we have added two more metrics to our “recession, not inflation” thesis we have been building. The stagnation of bank credit will reduce inflation expectations and the resulting slow decline in break-even points outlines a general timeline. Once inflation expectations begin to fall, which bank credit says will happen, a recession historically follows in about 15 months.
stocks and risk assets, including bitcoin, tend to rise and returns fall in the year leading up to the recession (as described last week). So, we have another confirmation that bitcoin should have enough headroom until the halving and next year.