Friday 4 December 2020 10:39 am

ETP and gold flows

Twenty-one percent of all dollars in circulation were printed in 2020 a number that  tends to be mentioned a lot by monetary policy doomsayers and Bitcoin maximalists alike; on the other side of the fence, arguments are that inflation is nowhere to be seen, let alone hyperinflation. 

With interest rates expected to remain near record lows for an extended period of time and the spectre of deflation stands close-by. Ironically, the UK’s Department of Business, Innovation, and Skills (BIS) did a historical study and found routine deflation was not a problem. According to the BIS – “Deflation may actually boost output. Lower prices increase real incomes and wealth. And they may also make export goods more competitive”. The so-called tail risk is that the US Federal Reserve (Fed) and other central bankers go too far down the rabbit hole unleash a different kind of monster – but tail risks like this very rarely play out in a dramatic fashion.

Gold is usually seen as the go to asset in the times of distress, economic uncertainty, and, of course, as a hedge against inflation. It ought to be remembered that, back in September 2019, the European Central Bank (ECB) and 21 other central banks that are signatories of the Central Bank Gold Agreement (CBGA), decided not to renew the agreement upon its expiry that month. The first CBGA was signed in 1999 to coordinate planned gold sales by the various central banks and, when it was introduced, the agreement contributed to balanced conditions in the gold market by providing transparency regarding the intentions of the signatories. It was renewed three times: in 2004, 2009 and 2014, until gradually moving towards less stringent terms. 

Since 1999, the global gold market has developed considerably in terms of maturity, liquidity and investor base.  And gold prices have increased around five-fold over the same period. The original signatories have not sold significant amounts of gold for nearly a decade, and central banks and other official institutions in general have become net-buyers of gold. Gold remains an important element of global monetary reserves, as it continues to provide asset diversification benefits, and none of them currently has plans to sell significant amounts of gold.

However, the above development did little to discourage flows into gold and, in fact, the events of this year propelled gold to a new record high past the $2,000 mark. The new high was least helped by the recent presidential election in the US and, while the outcome wasn’t a clear cut one, the calamity that some market participants feared also did not materialise. 

This, together with various developments relating to a much anticipated COVID-19 vaccine, and planned fiscal package (albeit delayed), has resulted in a material shift and capital rotation back into risk assets; so much so that analysts at Bank of America pointed out the largest outflow from gold ever, while also noting the largest inflow of equity funds ever. 

Meanwhile, flows into government bonds yielding less than zero percent surged to around $17 trillion, approaching the highest level since late 2019. Despite the aforementioned flows into government bonds, the overall trend of hunting for yield is undeniable. This is particularly evidenced by the recent performance by sectors such as energy, industrial and financials which helped the S&P 500 close the month of November with gains of almost 11 percent, and saw the Dow Jones Industrial Average make its biggest monthly gain since 1987.

However, it also appears that the fast-growing alternative digital asset class was also able to attract some of that risk capital. This view was echoed by analysts at JPMorgan who noted that the Grayscale Bitcoin Trust (GBTC) is outperforming gold exchange-traded funds (ETFs), a trend perhaps driven by institutional investors like family offices and hedge fund managers such as Anthony Scaramucci’s Skybridge, Ray Dalio’s BlackRock and publicly traded companies like Square and Microstrategy. 

Furthermore, this supports the notion that some investors that previously would have invested in gold ETFs, such as family offices, may be looking at bitcoin as an alternative to gold. In other words, the ascendance of the (GBTC) indicates it’s not just millennials driving demand for Bitcoin, but institutions as well. A similar view was voiced by analysts at Deutsche Bank who have also pointed out increasing demand to use Bitcoin as an alternative to where gold was used to hedge dollar risk, inflation and other things.

With that in mind, the market cap of Bitcoin would have to rise around 10 times from here to match the total private sector investment in gold via ETFs or bars and coins. However, given the propensity by Bitcoin to undergo parabolic price runs, together with the growing number of traditional firms entering the space, the indication is that this trend of Bitcoin eating into the market share of alternative assets will continue. 

As it stands, products offered by Grayscale, which include Bitcoin, Ethereum and others, lead the pack in terms of overall assets under management (AUM). The latest data shows that Grayscale has over $10 billion under management; and CoinShares, with just over $1.4 billion; followed by 21Shares and ETC Group (distributed by hanetf).

It is also worth paying attention to the short interest profile of GBTC, which has been rising steadily over the course of the year. For example, in early January it was in the mid-$200 million range, by mid-July this figure rose to mid-$300 million and, based on the reporting as of the end of October, $402.41 million was sold short. 

In essence, it appears  that GBTC may be used by some to construct spread trades. Of course, the other alternative is to hedge with futures and options, or a mix of both, for that matter, and, in turn, avoid the complications related to lock-ups; although that would mean being more active and to have some degree of infrastructure to trade digital assets, as opposed to GBTC shares.

Given the relatively small size of the current digital assets fund ecosystem, even small outflows from other forms of assets, be they gold or other alternatives, would result in outsized gains for digital assets markets. As such, correlating the flow to that of gold and, moreso, equity indices, or even bonds, should be taken with a grain of salt. 

However, the asset class has clearly passed the test of time and further regulatory evolution will only serve to encourage other market participants to consider allocating to Bitcoin as part of their broader alternative assets book. It is also important to remember that there is more to it than just Bitcoin.

Denis Vinokourov, Head of Research at BEQUANT Group ( / )


Crypto AM: Technically Speaking in association with Zumo