Sunday, May 2, 2021

The Recovery Is Here - Now What?

Last week showed just how great corporate earnings were, with a vast majority of the S&P 500 beating estimates significantly so far this earnings season.  The "low base effect" of being for the most part completely shut down last year for most companies contributed greatly to year over year growth, but analysts still got it wrong.  The stock market reaction in many cases was muted and many companies who otherwise reported excellent results and outlook sold off.  This will no doubt create some near term buying opportunities for great companies including Microsoft and Apple.  At the same time, the bond market sell off abated somewhat and rates stabilized (for example 10 year most recently at around 1.625%).  Could the markets be telling us that while we will see stellar near term growth and higher than normal inflation, the outlook for future growth - 2023 and beyond is anemic, possibly deflationary?  Will we see continued strong growth for years to come with higher than normal inflation? Or will we see weak or no growth and inflation (stagflation)?  The first scenario seems like the market signal, versus the other two.  With the stock market continuing to make all time highs, one concern weighing on investors' minds is the large amount of margin debt that has been taken on (an all time high), as shown in the chart below:


Growing margin debt is a significant area of concern because a sharp stock market sell-off could quickly cascade into a major downturn as a result of all this leverage, as brokerages issue margin calls, curtail margin lending and investors are forced to sell their stocks.  Ultra-low interest rates, strong stock market performance and very few other options for investors have all fed this borrowing binge.  Indeed, we have seen that recently in the Bitcoin options markets, with leveraged traders both long and short getting crushed at various times as the Bitcoin price rallied and fell, and as long term unlevered investors sat calmly on the sidelines HODLing.  Typically, the stock market peak has lagged the peak in margin debt by a few months.  The real question is when will we see the peak in margin debt and how long after that before the market peaks and goes into the next correction cycle?  A second and more important question is how bad will the correction be?  I have seen some investors such as Jim Rickards project as much as an 80% correction.  I sure hope he's wrong about that!

The 10 year treasury yield is sending its own signal about rising inflation expectations, after having bottomed at 0.55% last year in July, then rising to 1.65% at the end of April:


While this is a significant short term increase of 110 bps in a period of 9 months, it's not particularly rapid in historical context and we are still very close to all time lows for this important benchmark rate.  For example, in July 1979 the rate was 9.01% and by April 1980 it had risen to 10.76%, a 175 bps increase in 9 months.  We know in hindsight that period coincided with serious and pervasive inflation, which is why the rates were so much higher and now we are starting from a much lower level, having been through a period of very modest inflation.  If the bond market is processing all available information correctly, it is not seeing economic growth (the main driver of long term inflation) continuing at the current pace for very long and indeed, falling to perhaps lower than pre-pandemic levels.  Indeed, the CBO projection shows GDP trending back to about 2% over the next several years, as shown in the chart below.  The Conference Board projects 6% GDP growth in 2021 and 3.5% GDP growth in 2022 after posting -3.5% in 2020.  The huge amount of fiscal and monetary stimulus that was deployed last year and earlier this year (and more to come) is clearly driving the economic recovery.  All of this designed to "prime the pump."  But what happens when the stimulus effects burn off?  Will the pump run on its own?  Will we return to 2% growth or will it be even lower?  


After thinking this through, while there is definitely a short term threat of inflation, longer term it's not totally clear to me that we don't face an equivalent risk of deflation as stimulus wears off, supply chains normalize and technological innovation continues to increase efficiency and puts pressure on the labor market (both in terms of overall demand and also labor rates).  One of the long term consequences of the COVID-19 pandemic is the acceleration of corporate investments in technology to streamline process and leverage artificial intelligence and automation, which ultimately results in substitution of technology for labor.  As such, many jobs cut during the pandemic recession just won't be coming back.  If high unemployment is persistent, that will be a significant drag on economic growth.  At the same time, new jobs are forming rapidly as technology innovates, but there will be fewer of those and they will require different education and skills.  Either way, the Fed will have no choice but to keep short term rates low until labor markets recover and this could take quite some time.  This means cash will continue to offer no return and thus forcing investors into stocks, commodities, bonds and other assets.

How does all this uncertainty translate into an investing strategy?  As Ray Dalio has said, probably the best way for an individual investor to approach this environment is to be broadly diversified across many asset categories.  For the average investor, it's very difficult to trade in and out of positions and try to "front run" the market, which can shift daily if not by the hour.  This philosophy fits well with my concept of a Financial Fortress, which builds on a solid foundation of liquidity and focuses on broad asset class diversification.  

Over the past year or so, my view of the liquidity foundation of the Financial Fortress has changed in that cash no longer provides any return and is unlikely to for the foreseeable future.  I used to have a lot of my cash in US Treasury Bills, which I shifted to other assets recently.  This turned out to be a good move since last week the US Treasury sold 4 week bills for zero yield for the first time ever.  As such, after keeping enough cash on hand for short term needs, the rest of the cash is now invested in short term Treasury Inflation Protected Securities (31%), gold (15%) silver (16%), Bitcoin (32%) and a mix of large cap cryptocurrencies (6%).  In the long run, it's my belief that these investments represent "sound money" and will outperform cash held in a bank account significantly.  Whether inflation is a modest 2% or much higher, these investments should perform well over the longer term.  In particular, I think gold and silver are relatively undervalued right now based on everything going on with fiscal and monetary stimulus.  Bitcoin while extremely volatile still has a long way to go on its adoption path, is immutably sound money and has already demonstrated an incredibly asymmetrical investment opportunity over the past 10 years.  I think other cryptocurrencies such as Etherium and some of the other "alt coins" also warrant consideration as well due to their utility in the rapidly growing NFT and Decentralized Finance spaces.  Indeed, Coinbase will soon offer staking of Etherium with a 6% yield, which doesn't require you to hand over your coins to a third party and you can still achieve an attractive alternative to bank yields (of course you still have the risk of holding the cryptocurrency but if you are not leveraged, have a long term hold strategy and can stomach short term price fluctuations it shouldn't be an issue).  DeFi could seriously challenge traditional banking in the coming years.  

I have also reconsidered my "zero bonds" thesis and now think it makes sense to at least have some allocation to actively managed bond funds as a hedge against longer term deflation risks.  I'll have a complete update on my portfolio allocation in the next week or two that will reflect that change as well as other fine-tuning to broaden and improve overall portfolio diversification.

I hope you find this post useful as you chart your personal financial course and Build a Financial Fortress in 2021.  To see all my books on investing and leadership, click here.  

Stay safe, healthy and positive.  










Sunday, April 25, 2021

Bitcoin Investing and Broader Crypto Strategy

I have been doing a lot of research lately into cryptocurrencies, particularly in light of recent choppy price action and calls from a large majority institutions that Bitcoin in particular is in a "bubble."  While my contrarian attitude continues to push me to go a different direction from the crowd anyway, from what I have learned, we are still very much in a bull market across a number of indicators and the long term trajectory, particularly of Bitcoin, continues to be very positive as it has been for the past ten years.  


Global demand for a reliable store of value, fueled by declining value of fiat currencies due to pandemic induced monetary and fiscal policies that are inherently inflationary, will continue to meet immutably fixed supply.  As such, I still believe the crypto investment thesis is intact.  Buying and holding (with cash and avoiding leverage) continues to be the best long-term investment strategy for all assets, and particularly crypto due to the unusually good risk/reward characteristics for this asset class.

The first part of this post is about ways to hold your Bitcoin and how I have classified them in terms of risk / reward.  The second part is about a broader crypto investment strategy, since there are really a tremendous number of innovations in the space and many ways to participate in what will no doubt be transformational change in how we handle our finances in the years ahead.

Bitcoin Investing / HODLing

Ways to invest in Bitcoin, ranked from highest to lowest in terms of risk / reward:

  • 1) Buy and self-custody in offline wallet (I ended up buying the Trezor Model T along with a Cryptotag Zeus stainless steel private key storage device for some of my Bitcoin - so far I have been very happy with both; I do recommend you buy direct from Trezor to make sure you get full customer support)
    • Benefits:  you control your private keys and keeping your crypto in cold storage ensures you are never exposed to an exchange hack loss of your coins
    • Costs:  you will have to invest $200 - $300 for the hardware wallet and key storage device; if you lose your private keys your Bitcoin is gone forever with no possible way to recover; you also miss out on potential profits from staking your coin on an exchange (that has counterparty risk, however, as noted below)
  • 2) Online wallet with a secure, reputable exchange (like Coinbase, Crypto.com, Kraken, etc.)
    • Benefits:  very convenient to buy/sell/transfer; no need to worry about loss of private keys since they are kept by the exchange and account recovery is possible if you lose your credentials/phone/app temporarily
    • Costs:  exchanges charge fees either overtly and/or with a "spread" to the actual market value of the coin you are buying, so shopping around for the best fees especially if you are buying large amounts or frequently makes sense; risk of an exchange hack and loss of your coins (most of the major exchanges have dramatically improved their security over time to make hacking very difficult but it has happened before and will happen again)
  • 3) Buying into a Grayscale trust (GBTC, ETHE)
    • Benefits:  if you have a large amount of money to invest in a brokerage account, this is by far the easiest way to invest; no need to worry about security, regulatory oversight and audits since they have all three and the confidence of large institutional investors who also don't want the risk and hassle of self-custody; both trusts currently trade at a discount to underlying coins, which I think represents a nice upside opportunity
    • Costs:  you do have similar risks to coins on exchanges (risk of hack) although large trusts like Grayscale take even more extreme measures to ensure security including storing bits of private keys in multiple undisclosed locations; management fees come off the top of your returns which are fine in an up-market but can hurt in a down market (Grayscale currently charges 2%-3% for their funds but that is expected to come down when they convert to ETF's, when ETF's are approved in the US - in the meantime they are basically the only show in town) 
  • 4) Buying Microstrategy (MSTR)
    • Benefits:  you get exposure to Bitcoin with no management fees and are able to buy shares in brokerage accounts (IRA, etc.) where you might not be able to get direct exposure via GBTC
    • Costs:  like any other technology stock, MSTR can get beaten down with the rest of the tech sector in market selloffs and also faces other risks unrelated to its balance sheet Bitcoin holdings as an operating business
  • 5) Staking with a secure, online exchange
    • Benefits:  you can earn interest on your coins while you hold them, increasing your position over time
    • Costs:  you do face counterparty risk in the event that something happens to the exchange that you are handing your coins over to (bad investment decisions, insider fraud/theft, hack, etc.) and there is no insurance for loss, so you have to weigh the risk of loss with the reward - smaller balances that are staked are less of a concern than very large balances which may be better to keep in an online or even better, offline wallet
Thoughts on Broader Crypto Strategy

There is a tremendous amount of activity in the broader crypto space, with new developments literally every week.  It's very hard to keep up with all of it.  There is a lot of activity in DeFi or decentralized finance, which has evolved to decentralized exchanges where crypto assets can be pooled and pledged as collateral for loans and loaned/staked in exchange for interest payments, using smart contracts.  

This is a particularly interesting development in that you are no longer required to sell your crypto in order to monetize for fiat currency, since you can pledge your crypto assets as collateral and borrow in stablecoins (coins that are indexed to the US dollar) and use those for whatever the need is - your loan funds immediately and without dealing with a third party like a bank or having to fill out a loan application.  The higher your collateral level, the lower the interest rate.  Of course there is a risk in the event of a crypto market crash that you could could get a margin call, so it's best to only borrow relatively small amounts in comparison to your asset base to ensure you don't get liquidated and of course you'll eventually have to pay the loan back.  

Similarly, individuals interested in lending their crypto can do so and collect interest on the balance in the same currency.  These lending arrangements are also collateralized and if the crypto drops to a certain level, the collateral is returned to the lender, otherwise the lender just collects interest and ultimately gets the crypto back when the loan is paid off (which can also be paid off before maturity).  

Another interesting development in stablecoin demand is they have emerged as a great way for companies to settle international payments quickly and without the need for intermediaries who are very slow to process transfers (some can take days) and charge significant fees.  This may be another big reason why there has been so much growth in stablecoins recently.  

We have also heard a lot recently about Non-Fungible Tokens or NFT's as a potential revolutionary change in the way creators can transfer and monetize their digital works of art.  Payment for NFTs is generally facilitated by using Etherium.  See my recent post on the subject here.

What much of the DeFi and NFT spaces have in common is they are built on the Etherium platform, which I believe will mean growth in the demand for the Etherium tokens over time as a means of settling transactions on these different applications.  As such, I think investing in Etherium makes a lot of sense as a complement to Bitcoin, which I see as primarily engineered as a store of value asset not unlike gold or silver as a defense against inflation, but much easier to store and secure due to being digital vs physical.

One of the more obvious ways to make broader investments in the crypto space is to either invest directly in crypto exchanges like Coinbase (COIN), Bitcoin miners like Riot Blockchain (RIOT) or Crypto ETF's like Amplify Transformational Data Sharing ETF, Siren Nasdaq NexGen Economy ETF or First Trust Indxx Innovative Transaction & Process ETF.  These ETF's have broader exposure to the crypto space and companies operating in the space vs investing directly in cryptocurrencies like the Grayscale funds.  

I think following a broad diversification strategy across asset classes in accordance with the Financial Fortress model is critical and also within asset categories (such as crypto) it also makes sense to be diversified across direct crypto investments as well as companies involved in the space.  Possibly the highest rewards (and risk) would be private equity investments in the crypto space, but I haven't seen any that small individual investors can take advantage of on Seedinvest or StartEngine, maybe because there is plenty of capital available from high net worth individuals directly these days but hopefully in the future there will be more opportunities for smaller investors.  However, I did find one deal that was interesting on Republic for a company called Linen that might be worth looking into.   Full disclosure, I have investments in many of the stocks and funds mentioned in this post.

I hope you find this post useful as you chart your personal financial course and Build a Financial Fortress in 2021.  To see all my books on investing and leadership, click here.  

Stay safe, healthy and positive.  



Sunday, April 11, 2021

Portfolio Allocation Update

Time again for my monthly update on portfolio allocation.  Over the past month, I decided to shift away from TIPS and more into Bitcoin, increasing my overall allocation to Bitcoin and reducing my bond allocation to zero.  I decided to do this largely based on my ten year time horizon and desire to hedge against what I believe will be higher than normal inflation in the coming years and continued low or negative real interest rates.  I'm thinking inflation could be at least 3% to 5% in the US for a sustained period of time, but definitely more than 2% and hyperinflation is not in my base case.  I'm currently reading When Money Dies by Adam Ferguson and it's a pretty scary tale of what happened in the early 1920's with hyperinflation in Germany, Austria and Hungary - all I can say is I hope policymakers have learned their lessons from history.  I don't think TIPS will provide the best protection in this environment since I believe CPI understates the real rate of inflation due to calculation methodology changes over the years (not to mention excluding critical day to day items like food and gas).  

Here's a ShadowStats chart I have shared previously that shows actual inflation could be closer to 10%:  


The bigger issue in my mind for TIPS is the risk of yield curve management, where shorter dated securities including 0-5 year TIPS can be sold by the Fed in order to buy longer dated maturities to drive down long term interest rates.  This can depress prices of the shorter dated bonds and result in losses, a situation which could persist for some time - possibly years depending on inflation behavior, economic growth, unemployment and policy constraints.  This can be a problem for TIP holders, especially with very low yields (around 0.76% currently for VTIP).  We don't have to experience hyperinflation to do a lot of damage to cash and fixed income holdings in this environment.  Some day, of course, when real interest rates are positive and interest rates are higher, it may make sense to move some money back into cash and bonds but for now, that part of the market doesn't seem like a good place to be and many respected investors appear to share that view.

Here's the latest allocation:

  • Cash - 2.0%
  • US Large Cap Stocks - 16.5%
  • US Mid Cap Stocks - 5.5%
  • US Small Cap Stocks - 5.6%
  • Emerging Markets - 5.3%
  • Commodities - 5.5%
  • Real Estate - 22.1%
  • Private Equity - 10.2%
  • Bitcoin - 23.2%
  • Other (Gold/Silver/Royalties) - 4.1%
I have been reading lately that some analysts believe hard assets are relatively undervalued in this environment (vs financial assets such as stocks), including real estate, precious metals and collectibles.  While I don't have any collectibles in my portfolio (see my post last week on NFT's), I do have a healthy allocation to real estate and precious metals.  I do believe that gold and silver look attractive at current levels.  My equity portfolio includes some direct exposure to gold miners as well as cyclical, tech and natural resources companies.  I still believe, consistent with the Financial Fortress methodology, that broad diversification is critical to protect your portfolio over the long term, especially since it's very difficult to predict what will be "working" as markets shift through their cycles (i.e., growth vs value) and as macro conditions evolve.  

Future Bitcoin price predictions range widely, but I feel pretty comfortable that the price will continue to appreciate over the next 10 years at a rate that will substantially exceed inflation and therefore will provide a good store of value.  The short-term volatility is expected to go down over time as Bitcoin gains more institutional adoption and acceptance / use continues to grow.  My Bitcoin holdings are primarily Grayscale Bitcoin Trust (GBTC), Bitcoin held in a Crypto.com account and Microstrategy (MSTR).  If you're interested, I recently did a post here on ways to invest in Bitcoin.  There are currently several applications pending with the US Securities and Exchange Commission for Bitcoin ETF's, but so far none have been approved in the US.  There are a couple of popular ETF's approved in Canada.  Also, GBTC's sponsor has said they intend to convert to an ETF (they are a currently organized as a closed end fund) as soon as practical.  When/if these ETF's are available, this will give investors more options to own Bitcoin.  Although hard-core Bitcoiners say you should self-custody (not your keys, not your Bitcoin), some people may not want to deal with the potential risk of loss of Bitcoin that is in self-custody.  The main value proposition for a fund or ETF is convenience (in a brokerage account) as well as peace of mind, since they have robust security, regulatory oversight, audits, etc.  That especially appeals to institutional investors who may not have the expertise or risk appetite for self custody.  

Last week, I watched an interesting interview with Mark Cuban, billionaire owner of the Dallas Mavericks and regular on Shark Tank.  He has developed a deep understanding of the blockchain space and while he is bullish on Bitcoin for its store of value thesis, he's more interested in Etherium as an enabler of smart contract transactions across the blockchain and particularly with respect to NFT's, an area he has already made several investments.  He also has a bit more of a "real world" perspective of how most people will respond to crypto adoption, which is somewhat refreshing.  That got me thinking that maybe a small allocation toward Etherium (1% - 2%) might make sense in a broadly diversified portfolio.  The argument against Etherium is that it is still very much a "work in progress" as a protocol and therefore is more speculative than Bitcoin at this stage of its evolution.  The investment thesis would be that continued growth in demand such as NFT's (which require Etherium for payment settlement and the to support the underlying smart contracts that allow creators to collect royalties in perpetuity) would drive corresponding demand for Etherium and which would therefore result in rising prices over time, perhaps at times even better performance than Bitcoin.

I hope you find this post useful as you chart your personal financial course and Build a Financial Fortress in 2021.  To see all my books on investing and leadership, click here

Stay safe, healthy and positive.  




  

Sunday, April 4, 2021

NFT's - I'm Cautiously Optimistic

Non Fungible Tokens (NFT's) are original digital collectibles or works of art that are stored on a blockchain.  Already, there have been many famous NFT's, including the recent sale at auction of the digital artist Beeple's "5000 Days" for over $69 Million.  Because the artwork was transferred to an NFT, it is a digitally secure "original" and while it can be copied online and printed out or reused many times over, there is only one original, it's authenticity and ownership secured by the blockchain.  

What's more interesting about NFT's is that all sorts of digital artwork creators can take advantage of this not only as another way to create and distribute their work directly to fans, but also to more efficiently monetize their work and ensure they receive royalties both at the point of original sale and in the future.  Because smart contracts are used, they can be programmed to share a percentage of each resale of the original work of art with the creator as the piece changes hands in the future (presumably for more money) - this is revolutionary and cannot be replicated in the real world.  For this reason, I think most NFT's will probably benefit the artist more than the buyer and can also allow more artists to reach a global audience than ever before with their work.  From the buyer's perspective, but there could be some limited edition pieces that go up significantly in value - either due to viral popularity of a previously unknown artist and / or after the passing of the artist.  It's possible, however, for the owner of the NFT to find ways to monetize the value of their digital art piece other than selling it in the future - possibly charging a fee for showing the piece in a digital museum or using it as collateral for a loan.  Clearly, not everything being offered for sale today will have value in the future, so if you are interested in investing in NFT's it will pay to be cautious.  

Many artists and creators are getting into the game.  A couple of weeks ago, Time Magazine auctioned off some of its most iconic covers as NFT's, including "Is God Dead?" and "Is Truth Dead?" and a new cover based on the other two "Is Fiat Dead?"  These covers sold for between 70 and 80 ETH ($140K to $160K based on recent price).  More recently, musical artists Snoop Dogg and Boy George have created and are offering limited edition NFT's for sale on Crypto.com's new NFT site.  Crypto.com's approach is to offer "drops" for a limited time and then limited quantities of each NFT.  Purchasing an NFT requires you to buy cryptocurrency to complete the transaction.  Typically this has been Etherium, but with Crypto.com they leverage their own CRO coin on their site.  The rise of NFT's will obviously increase the demand for the cryptocurrencies used to purchase the items, which should help increase the value of the cryptocurrencies used over time, especially if supply is limited similar to Bitcoin.  I still prefer Bitcoin as an investment and store of value vs the other cryptocurrencies, although it's not easy to be a long term holder - see my post from last week on dealing with fear, uncertainty and doubt.

Collectibles, including rare works of art can be a lucrative investment but you have to really understand the market for the items you buy.  Some collectible items that are only represented physically like coins, stamps, baseball cards and the like could some day have digital counterparts but that's one I have a hard time getting my head around.  It's one thing to have a song, video clip or piece of digital art (or all three combined in some cases) natively created in a digital format and put on an NFT.  Indeed, this is what all the current generation of NFT's are.  It's a whole other thing to create a digital representation of a physical thing for a peer to peer transaction, without involving a third party such as an escrow agent.  However, in terms of documenting change of ownership of a physical thing without an intermediary including setting and enforcing contractual requirements, the blockchain does have huge potential.  The applications for this are truly immense (think about buying and selling homes or cars, for example).

In terms of the Financial Fortress, collectibles do have a place in a portfolio, although I would recommend a small percentage at least to start with.  Maybe 1-2%.  As you gain confidence in the process and the assets you are interested in accumulating, a higher allocation may be warranted.  With Bitcoin, I started with a small 1-2% allocation and have raised it steadily as my confidence in the asset has grown while still making sure I'm maintaining my overall portfolio diversity.  The same could be true of NFT's, although I have yet to invest in any.

I hope you find this post useful as you chart your personal financial course and Build a Financial Fortress in 2021.  To see all my books on investing and leadership, click here

Stay safe, healthy and positive.  


  

Sunday, March 28, 2021

Dealing with Bitcoin FUD

If you are like me and have devoted a significant portfolio allocation to Bitcoin, it's relatively easy to fall prey to the "FUD" or Fear, Uncertainty and Doubt that is often spread by the media directed at Bitcoin.  It comes and goes in waves and usually peaks after a big run-up in the price of Bitcoin.  As a long term investor, it's important to do your own research, your own thinking and stick to your strategy - whatever works best for you.  I have found that Bitcoin requires a significant amount of research to understand how it works, but having done that research I still learn more every day and I continue to be committed to having a "nonzero" position in it.  

Here are some of the most common types of Bitcoin FUD:

  • Governments will "outlaw" 
  • It's a "bubble"
  • It's a Ponzi scheme
  • Something better will come along
  • There's nothing of tangible value (unlike gold or silver)
  • It will crash 90% 
  • It is used for illicit / criminal activity
Whenever something is new, it's difficult for most people to see the potential.  This could be said of many inventions in the past, such as electricity or the automobile or more recently, the internet.  I recently watched a video clip of Bill Gates on the David Letterman show in 1995 explaining the internet and what it does and Letterman was cracking lots of jokes about it.  I believe the current status of Bitcoin is much like the early internet days and you have similar camps of believers and naysayers, both are equally convinced they are "right." 

When you think about Bitcoin, its most obvious use case is as a commodity similar to gold, where it can be used as a store of value.  In fact, that's exactly what Bitcoin was engineered to be:  programmatically safe, sound money that cannot be debased.  Where Bitcoin is superior to gold is in how it can be stored and transferred digitally at very low cost compared to gold.  Indeed, it is impractical to store and transfer large amounts of physical gold.  Bitcoin is already recognized in the United States as a commodity and many investors believe that as long as the government is able to maintain regulatory control over Bitcoin and get their tax revenue from the sale of Bitcoin (approving Bitcoin Exchange Traded Funds in the US will go a long way toward these objectives), Bitcoin should have a path forward in the US.  

Banning Bitcoin would be silly and a few countries that have tried like India and Nigeria have had to walk that back because ultimately it puts your country at a disadvantage to the rest of the world that is adopting Bitcoin.  It's also practically very difficult to do with a decentralized digital asset.  Also, with a $1Trillion market cap, an outright ban on Bitcoin would be an unconstitutional taking of property and would be extremely unpopular.  There is a whole industry and ecosystem growing up around Bitcoin and that means jobs, many of which we can't even conceive of today.  That's important for economic growth and governments will hopefully soon realize that is the case.  

The more intriguing use case for Bitcoin is the concept of using it as a "base layer" of a new digital decentralized financial network.  Many people are familiar with Etherium, another digital currency that supports "smart contracts" using blockchain technology and that allows for all sorts of financial innovation.  However, the Etherium protocol, although popular, is still a work in progress technically while Bitcoin is essentially a completed project.  What I have learned recently is that there are entrepreneurs who are developing similar smart contract protocols that can work on top of the Bitcoin network, leveraging its large computing base and extremely strong security.  An example of this is Stacks.co.  This next generation of financial technology can bring the best of both worlds together allowing for low cost, rapid and secure "smart" financial transactions without the need for an intermediary and leveraging the Bitcoin protocol for settlement and payment.  I think this is probably the most compelling use case for Bitcoin and one that could dwarf the demand driven by investors and corporate treasuries as an alternative asset.  

Ray Dalio, an investor I have a lot of respect for, created a stir last week by suggesting that it's probable that Bitcoin could be outlawed in the US and other countries (indeed, as noted above that has already been happening).  While that is indeed a possibility (gold ownership was outlawed in the US for many years), I think this only happens if Bitcoin becomes a threat to the demand for US Treasury debt.  The government needs to be able to issue a lot of Treasury debt to fund operations and ongoing stimulus programs and the Federal Reserve doesn't want to be the only one buying all those bonds for obvious reasons (i.e. monetary inflation through monetization of the debt).  I think that only happens in a hyperinflationary scenario in the US, which seems very unlikely.  The Federal Reserve, even if they are late to the game, cannot allow inflation to get out of hand although they can let it "run hot" for a while which should do plenty of damage to cash and bond holdings.  Stocks, especially cyclicals, will continue to see a boost in this environment since investors have no other good investment alternatives (gold and silver have done nothing, which is why investor demand for Bitcoin as an alternative asset class has been so strong).  

Also, as Cathy Wood, another great investor I follow says, there are very powerful deflationary forces at work in the world today due to technological innovations.  Indeed, you really don't have strong inflation without wage inflation and until the unemployment rate is extremely low, you won't see wage pressures.  My own observation from the COVID19 pandemic and recession is that many of the jobs that were lost may never come back since companies have rapidly accelerated adoption of technology to replace labor, which means that wage inflation may have a tough time taking hold.  If we see any signs of deflation, investors will run right back into Treasuries, which was what we saw during the Great Recession and also more recently last year and whenever an economic downturn happens.  That would solve the Treasury demand problem and many investors (as they have been until very recently) might still be willing to accept zero or slightly negative real rates of return in exchange for "safety."

The volatility of Bitcoin is expected to settle down as it gains adoption and over the long haul, should approach a more "normal" rate of appreciation commensurate with inflation.  In the meantime, the network effect will be a major driver of the price of Bitcoin, since greater use as an alternative investment, more use cases and a fixed supply will continue to drive the price up.  The nature of the network effect is that there is a massive advantage to the first mover (in this case Bitcoin, which is the first global monetary network) and the only way you are disrupted is if something comes out that is 10x better.  While that's a possibility, the first-mover advantage is huge as we have seen with the likes of Amazon, Google, Facebook, Netflix, and Apple.  If you are going to own Bitcoin, you have to be willing to hold regardless of the price action, whether up or down, with a time horizon of at least 10 years I believe.  Bitcoin will continue to be volatile in the near term, that much is certain. 

A Ponzi scheme usually has a sponsor who is making money at the top by taking in investments, keeping most of the money for personal use or funding the occasional redemption and paying out a small amount to investors as a "return."  Bernie Madoff was running such a scheme - the largest in US history - and was able to do it for years by showing great results to his investors, and it all fell apart when the stock market crashed during the Great Recession.  The Ponzi falls apart when new investors stop coming in and the operator is unable to pay interest or redemptions to existing investors.  Based on this definition, Bitcoin can't be labelled a Ponzi scheme because as a decentralized platform there is no central sponsor who is enriching themselves at the expense of new investors and there's certainly no faking the price of Bitcoin since it is actively quoted and traded 24 hours a day, 7 days a week.

As far as criminal activity, ironically Bitcoin is probably the worst way for criminals to transact because the blockchain is open and everyone can see it.  This actually makes it easier for law enforcement to "follow the money."  Historically dollars (especially paper bank notes in suitcases) have been used for way more illegal activity than Bitcoin has.

In conclusion, while there is plenty of FUD out there, when you look at the facts there's not much reason to be concerned if you have a long-term buy and hold approach to Bitcoin.  Your percentage allocation should be in accordance with your comfort level and I certainly am not recommending going "all in," as some have done.  It still makes sense to have a diversified portfolio consistent with a strong Financial Fortress, since not all assets are always "working" at the same time.  The outlook for cash and bonds with ongoing monetary and fiscal stimulus not just in the US but globally, suggests that a higher allocation to alternatives such as Bitcoin make sense in the current environment.  

I hope you find this post useful as you chart your personal financial course and Build a Financial Fortress in 2021.  To see all my books on investing and leadership, click here

Stay safe, healthy and positive.  

  


Sunday, March 21, 2021

Gold and Silver Update

Gold has been in a down trend since hitting a high back in August 2020 at $2,038 per ounce and has mostly been trading sideways in a range between $1,750 and $1,850 per ounce over the past six months (see long term chart below).  Recent volatility in the bond market with long term interest rates spiking has caused more downward pressure on gold, hitting a low of $1,685 on March 8, from which it has bounced back up to around $1,739.  Many investors believe gold has been consolidating since August and will eventually begin a steady move up, driven by massive fiscal and monetary stimulus in the US which is expected to cause inflation (and possibly a rotation from stocks and bonds into commodities).  As I have written about before, a Financial Fortress comprised of a diversified portfolio should include an allocation to precious metals, including gold and silver.  


As I discussed in my book Investing in Gold and Silver, there are many ways to invest in gold and silver.  The most popular way is to simply buy coins and bars and securely store them.  Lately this has become a challenge, especially for silver, with the #silversqueeze movement which has been encouraging individual investors to buy as much physical silver as possible to expose perceived manipulation of the "paper" silver market (futures contracts being sold with no physical backing).  You can find silver coins, but they have a hefty premium to the spot price of silver - a quick survey of EBay had many monster boxes available in the $17K range (each monster box includes 500 one ounce US liberty silver coins, implying a physical price of $34 per ounce while the spot price is about $26 - a 30% premium to spot).  Having physical possession of gold and silver is comforting to some investors and for many it is the only way they want to hold precious metals.  Storage and security can become a problem depending on how large your holdings are, however.  

Alternatively, you can invest directly in common stock of gold miners such as Barrick Gold (GOLD) or  Wheaton Precious Metals (WHT).  If you are looking for diversification across several of the larger miners, you may be interested in investing in ETF's such as the Van Eck Gold Miner's Index Fund (GDX) or if you want exposure to the smaller "junior" miners, you can invest in the Van Eck Junior Gold Miner's Index Fund (GDXJ).  There is also "paper" ownership of physical gold and silver through one of the ETF's like Sprott Physical Silver Trust (PSLV) or the SPDR Gold Shares ETF (GLD).  These ETF's buy and hold physical gold and silver in vaults - the value of the ETF shares reflects the value of the stored gold and silver, less storage and administrative costs.

I recently learned of a new way to invest in metals that I hadn't heard about before.  There are some companies that are formed to invest in metals royalties.  These companies own the rights to the claims and get paid a set amount or percentage for gold, silver and other metals that are extracted from the claim.  They have none of the cost risk that miners often face and so are a leveraged way to invest in metals since they are very sensitive to an increase in price of the underlying metals and of course, production levels (more gold at higher prices equals higher royalty payments).  One such company is Metalla Royalty and Streaming, Ltd. (MTA), which engages in the acquisition and management of precious metal royalties, streams, and similar production-based interests. It focuses on precious metals such as gold and silver. The company was founded on May 11, 1983 and is headquartered in Vancouver, Canada.  While this stock has performed poorly so far this year (down 28%), when gold prices turn around it could see some significant upside due to the leverage discussed previously and may be worth a look in a diversified portfolio as part of precious metals allocation.

I hope you find this post useful as you chart your personal financial course and Build a Financial Fortress in 2021.  To see all my books on investing and leadership, click here

Stay safe, healthy and positive.