As Bitcoin surpasses again $10k, its inflation hedging will finally tested

Yesterday, we saw a strong increase in bitcoin above the $10,000 resistance against the US Dollar. BTC extended its rally above the $10,200 and $10,500 resistance levels to settle above a couple of crucial hurdles.

There was a break above the $11,000 level and the price settled well above the 100 hourly simple moving average. A new monthly high is formed near $11,422 and it is currently consolidating gains. It corrected lower below the $11,200 level.

However, the 50% Fib retracement level of the recent rally from the $10,275 low to $11,422 high acted as a strong support near $10,850. There is also a major bullish trend line forming with support near $10,8s00 on the hourly chart of the BTC/USD pair.

The trend line is close to the 61.8% Fib retracement level of the recent rally from the $10,275 low to $11,422 high. On the upside, the $11,500 level is a major hurdle for the bulls.

If there is a downside correction, bitcoin is likely to find bids near the $11,000 and $10,800 levels. The main support is now near the trend line and $10,500.

Any further losses could lead the price towards the $10,300 support zone. The next major support is near the $9,800 level and the 100 hourly simple moving average.

Earlier this year, digital-asset investors were aflutter over the trillions of dollars of central bank money injections in response to the coronavirus-induced global recession. The bet was the flood of liquidity would eventually lead to inflation, in turn driving up prices for both gold, historically seen as a hedge against currency debasement, and bitcoin, sometimes referred to as “digital gold” or “Gold 2.0” due to its scarce supply.

Yet, since the end of April, when the coronavirus-related market gyrations subsided, bitcoin has lagged behind gold, frustrating the cryptocurrency’s investment narrative.

Gold prices have surged during the period, last week topping the all-time closing high of $1,891.90 an ounce reached in 2011, and are now trading at a record intraday high of $1,940 per ounce. The previous lifetime high of $1,921 was reached in September 2011.

Bitcoin, meanwhile, has been stuck in a narrow trading range since April and only just last night clambered to $10,200, a level not far off half of its all-time-high of $20,000 reached in 2017.

Bitcoin is far less mature than gold and thus may lack a credible history as an inflation hedge. So it’s struggled to draw hedging bids despite a recent uptick in inflation expectations.

Bitcoin’s inflation sensitivity hasn’t been tested in the last 10 years as there hasn’t been a sustained rise in price pressures.

It’s a shift in tone from a few months ago, when the bullish hype over bitcoin was so ubiquitous it crowded out any reservations about bitcoin’s limited trading history or market size. Suddenly, there’s no shortage of caveats to explain why bitcoin hasn’t reflected the inflation expectations that seem to be buoying gold.

To add insult to injury, other corners of cryptocurrency markets are white-hot: ether, the second-largest cryptocurrency after bitcoin, has gained some 150% this year. Bitcoin is up 42% in 2020.

Bitcoin has its own microeconomics very unique to crypto, including mining difficulty cycles, the changing regulatory environment and other factors that have little to do with inflation.

U.S. inflation expectations, as implied in the market for the U.S. 10-year breakeven inflation rate, have risen to 1.51%, the highest since February. They’ve climbed from 0.5% on March 19, as the Federal Reserve’s balance sheet expanded by more than $3 trillion.

Bitcoin initially rose alongside the uptick in inflation expectations. The move from $3,867 to $10,000 seen in the two months to mid-May was likely fueled by the bullish narrative surrounding the May 12 halving. Since then, the cryptocurrency was locked in the range of $9,000 to $10,000 up until July 26, while inflation expectations continued to rise.

Gold, however, has drawn a consistent bid over the past four months, given its long history of serving as an inflation hedge.

The yellow metal rose by an average 15% in real or inflation adjusted terms in the eight years between 1974 to 2008 when annual U.S. inflation, as measured by the consumer price index, was above 5%, according to the Journal of Wealth Management. Gold more than doubled to about $1,920 from $850 in the three years following the mid-2008 crash, as the Fed’s emergency liquidity injections pushed inflation expectations higher.

Indeed, bitcoin’s entire existence, since it was launched in early 2009, has taken place in a low inflation environment. The 10-year breakeven inflation rate fell from 1.6% to -0.62% in the two years through 2013, and it remained stuck in a range between 0% and 0.8% from 2014 to January 2020. That’s well below the Fed’s 2% target for annual inflation.

The gold market, at around $10 trillion, has sufficient depth and liquidity to absorb large hedging-related or haven inflows. Bitcoin’s market capitalization is comparatively paltry, at $189 billion.

Another factor stopping institutions and other traditional investors from making big portfolio allocations to bitcoin is a belief that its price action and network fundamentals aren’t as intimately connected as gold to the fate of the global economy.

Central banks, which don’t invest in bitcoin, often buy gold in times of stress, and they were net buyers during the virus-stricken first quarter, according to the data source Gold Hub. But today’s crisis is different due to the tune of money printing. Moreover, gold has been demonetized long ago and people aren’t accustomed to it anymore. And it goes without saying that if gold would ever return as a monetary standard, it will be fully centralized. People don’t need more of the same, they need to rely again on their savings. Capitalism needs to rely again on pure savings. This means a return to a sound and honest form of money. And that means Bitcoin.