by Dan Clarke & Jesse Knutson, Institutional Sales
DISCLAIMER; This post and its contents should in no way be considered investment advice.Bitcoin re-emerging as a defensive asset? Maybe.
As we highlighted in a recent piece, Bitcoin has been highly correlated to the emerging markets during the recent sell-off. However from March 2015 to March 2017 Bitcoin saw a strong negative correlation with the Chinese currency, rallying hard into CNY weakness. This negative correlation then reasserted itself during a sharp rally in CNY heading into Q1 2018 which saw the Bitcoin price crushed. Through 2H 2018 we are starting to see Bitcoin show very early signs of re-asserting its negative correlation with CNY, performing like a defensive asset much like the recent price action in Gold. In addition with BTC -0.3% post Emerging Markets ETF (EEM) -3.2% overnight, this seems to add some weight to the theory.
The Bitcoin China Narrative
On a recent trip to Hong Kong where I visited institutional clients, there was a leading narrative amongst investors that much of Bitcoin’s weakness was China related. The narrative was that many Chinese were selling what they could (Bitcoin), not what they wanted given a liquidity crunch reverberating through out the Chinese economy.
The idea of growing troubles in China’s economy is nothing new and has been touted by many over the last few months and can visually be seen in the 11%~ weakening of CNY since April coupled with an 18%~ slide in the SHCOMP.
Much of this weakness has been mirrored across the emerging market space as the US$ appreciated & trade war rhetoric between the U.S and many of its key trading partners across the globe accelerates in the run up into the November mid-term elections.
An Experts View on the Yuan — Likely to get Weaker
I recently watched a great interview with American hedge fund manager Kyle Bass on @realvision. Three quotes from Kyle stand out:
“And if all of these things play out the way we think they’re going to play out, then that number’s <Referring to the value of the Chinese Yuan RMB> going to be dramatically different than it is today, and it’s going to be a lot weaker”.
“I’m not saying it’s tomorrow <Referring to timing of a possible RMB devaluation>. I’m just saying that their current account’s in a bad shape, we’re imposing tariffs, and we haven’t even started to discuss the bill that we’re going to put in front of them for all the IP theft”.
“Interestingly enough, given our trade conflict, today we’ve served up an interesting plate to President Xi or Emperor Xi, whatever you want to call him, Winnie the Pooh. The way you look at it now is we’ve put him in a position where if he were to do, if he were to weaponize the currency <In reference to a devaluation>, and that’s how the world would see it, it would look like a move of strength, and we all know he has to do it at some point in time”.
Spreads & Correlations Mostly Support the China Narrative
Looking at the spread & correlations between CNY & BTC, it mostly backs up the narrative of a weakening in CNY leading to a weaker BTC price. The first chart below shows the spread between BTC/CNY & shows the 120-day rolling correlation at 0.5119. Correlation is currently at the upper bounds of the range over this period but appears to be weakening. If that trend continues, & the Yuan were to continue to weaken, we could potentially start to see some negative correlation re-emerge to take Bitcoin higher during a weakening phase of CNY, but its probably a stretch right now to call that based purely on the data.
The 2nd chart is the regression scatter plot over the last 2 yrs — showing that BTC has a 66.6% +VE correlation with CNY price movements during that time. The R-squared of 44.4% tells you that over this time period the price movements in BTC were explained by 44% of the price movements in CNY. So as CNY weakened, BTC tended to weaken.
So, if we assume Kyle Bass & the mainstream pundits are right, in that China’s currency is likely to continue to weaken, should we expect this to be positive or negative to Bitcoin and the broader digital assets space?
Below is a chart that shows Bitcoin vs CNY for the period of Mar 2015 to Mar 2017. What this chart shows is that as the CNY weakened, Bitcoin strengthened. This makes sense. We know that during this period the Chinese were very dominant in Bitcoin, whilst Bitcoin was frequently touted as the preferred vehicle to escape this currency weakness in CNY.
China eventually shut down all crypto exchanges in Q4 2017, whilst still allowing withdrawals for a small period after. This coupled with the subsequent strengthening of the Yuan going into 2018 (See chart below) saw Bitcoin smashed in Q1 of this year. The second key observation from the below chart is that during the recent sharp sell-off in CNY in 2H 2018, Bitcoin remained largely stable but the negative correlation was largely broken (Bitcoin failed to rally on CNY weakness). This can be explained by:
- China’s crackdown on allowing Chinese to buy Bitcoin (It was now harder for Chinese to hide in Bitcoin as Yuan weakened)
- The current CNY weakness being associated with a credit crunch whilst 2015–2017 was not, potentially resulting in the Chinese holders of Bitcoin being forced sellers (Selling what they can, not what they want to).
But Why is Bitcoin so Resilient in face of Chinese Selling?
So if we get back to the current narrative that says the Chinese have actually been the main sellers during this recent bout of Chinese currency weakness, why has the Bitcoin price been so resilient? Could it be that Chinese credit crunch selling has been absorbed by the global crypto bulls who are focused on the many positive developments surrounding Bitcoin & crypto’s move into mainstream finance? Maybe the extent of that selling has been overplayed & we are starting to see these flows dry up?
Whilst the weakness in CNY reflects both US$ strength & a domestic credit crunch, does the recent evidence necessarily support the idea that Bitcoin has broken its negative correlation with the CNY (that existed through 2015–2017 bull market and in the sharp sell-off in early 2018)? Certainly the correlation data from earlier shows a mild positive correlation over the last 12–24mths. However If we drill down to price action over just the last 5 months it’s very hard to argue that necessarily being the case. In fact Bitcoin maybe starting to go back to being negatively correlated to CNY again.
As we can see from the chart above in the initial sharp fall of the CNY from July-August 2018 (Red arrow), Bitcoin actually strengthened significantly (Green arrow). In addition, over the last 4–6wks whilst the CNY has again continued to weaken after a period of consolidation, Bitcoin has in fact been moving higher. So whilst Bitcoin has overall been positively correlated to emerging markets and the CNY over the last 12mths, we may be seeing the beginning of a shift towards Bitcoin acting as a safe haven asset or digital gold?
Another data point that could support this can be seen in the recent moves of US$ vs Gold. As the chart below shows, after being negatively correlated for most of 2018, Gold has recently become positively correlated with the US$ rise. It is also starting to perform as a safe haven.
The only question left to ask is what happens if all the pessimism around CNY & emerging markets more broadly is overdone & risk assets rally back? Will this drag Bitcoin lower given its recent defensive properties or will Bitcoin re-assert itself as the risk-on king. Believing the latter would mean Bitcoin can’t lose either way!
DISCLAIMER; This post and its contents should in no way be considered investment advice. We may individually hold positions in some of the assets we discuss. Any projections, conclusions, analysis, views are to be considered hypothetical & for informational purposes only & not meant as recommendations for investment. Anyone considering an investment in crypto should only invest what they can afford to lose. You alone are responsible for evaluating the risks & merits of our content.