Adam Sharp

Gold and Bitcoin Are Critical Inflation Hedges

The entire U.S. stock market is currently valued at around $53.9 trillion. That’s all the companies on the NYSE, Nasdaq and OTC markets combined. 

During the 2008 global financial crisis, the whole stock market was valued at just $11.4 trillion. The market capitalization is up almost five times in 13 years.

The U.S. stock market is tremendously large, accounting for 55.9% of the entire world’s market cap. That’s partly because we have amazing global brands like Nike, Apple, Amazon, Google, Microsoft and countless others.

But stocks are also just flat-out expensive right now. The proof is in Warren Buffett’s favorite metric, the Buffett Indicator. 

The Buffett Indicator compares the value of stocks to GDP to measure if stocks are undervalued or overvalued. The higher it is, the more expensive stocks are compared with the underlying economy. Today, the Buffett Indicator shows a level of 235% market value to GDP. 

The recent spike in value is nearly vertical. 

(Note: this is according to CurrentMarketValuation.com, which provides detailed information on its methodology. There are other interpretations of the Buffett Indicator, using different data, that say we’re less overvalued than CurrentMarketValuations claims. YCharts, a large financial data service, puts the number at 205%. But it’s still very overvalued.) 

Bonds: Also Ridiculously Overvalued

The total value in the U.S. bond market today is around $46 trillion. America accounts for a whopping 39% of the global bond market, which stands at $119 trillion.

Much like stocks, bonds are very, very expensive right now. As the price of a bond goes up, the yield goes down. And right now, yields are extremely low. The U.S. 10-year treasury note yields just 1.23%, well below the current roughly 5% inflation rate. So over the last year, 10-year treasury note holders have lost approximately 3.8%, according to official inflation numbers. And that’s before tax…

Bond prices can’t go much higher, and yields can’t go much lower, unless bond yields go negative (meaning bond investors would be losing money both before and after inflation is accounted for). 

The Appeal of Bitcoin and Gold in This Environment

Inflation jumped by 6.1% in the second quarter of 2021 according to official numbers. That’s the highest rate since the 1980s. 

There’s a chance the spike is being caused by supply chain problems related to the COVID-19 pandemic, as many mainstream economists claim. But there’s also a chance that it’s being caused by the incredible amount of money being pumped into the system by the Federal Reserve. As Lyn Alden, one of my favorite financial thinkers, showed on Twitter, the money supply is still growing quickly. 

If inflation turns out to not be “transitory” as the Fed and Treasury claim, I believe there will be a rush into alternative assets and inflation hedges. 

In this inflationary scenario, the stock market should do better than the bond market. But many industries and companies without pricing power will struggle as their costs rise. And with the U.S. stock market valued at $53.9 trillion, even a small amount of money shifting from stocks into bitcoin or gold and gold miners could have a massive effect on gold and bitcoin prices. 

I believe the larger concern is the $46 trillion domestic bond market. What happens if inflation sticks around the 5% to 6% level for a few years? Are bond holders simply going to sit there and lose around 4% a year (and likely more based on more realistic inflation numbers)? It’s certainly possible, but I believe a significant portion of them will move their money into alternative investments. 

The stock market is the standard alternative to bonds. But with share prices being so expensive, I think some investors will seek out other inflation hedges. I suspect this at least partially explains the soaring real estate prices across the country. Real estate is a time-tested inflation hedge.

Gold and bitcoin are also popular ways to hedge against inflation, and I think this will continue to be the case going forward. Based on the size of domestic bond and stock markets alone, I think we could see fireworks in gold and bitcoin prices in coming years. 

Needless to say, there are risks to this strategy. If the Fed does raise interest rates substantially, gold and bitcoin will struggle. But I strongly believe that there’s no way the Fed can normalize monetary policy now. As I often say, there’s simply too much debt and leverage in the system. We need sustained inflation for more than 5 years to get debt down to more normal levels. 

So I plan to hold my bitcoin and gold investments for many years to come. There will be ups and downs, but overall I think prices are going higher. 

To dive deeper into my thoughts on inflation hedges and bitcoin, check out some of my related articles:

Have a great weekend, everyone.