Gold 2.0

There are few things in financial markets more newsworthy than parabolic moves. Yesterday's front page of the Wall Street Journal featuring the Bitcoin chart, like the one above, is a recent example of the phenomenon. I always pay attention any rally that 'makes the cover', and I watch for anecdotal evidence that bolsters the hype. We call it the 'cab driver' effect.

I was recently asked by a millennial aged contact, "what do you think of Bitcoin?". Contrast that query to the puzzled looks I got from a group of Boomer friends, when I informed them I had recently been speculating on Bitcoin (I'm out now). They said "I think I heard about that - what is it?"

So, what is actually behind the speculative run in the crypto-currencies?

Initially, cryptocurrencies leveraged the invention of blockchain technology to create a medium of exchange for the world of e-commerce. Their successful adoption has been enhanced by Japan's validation of bitcoin and the IRS's position paper on cryptocurrency as an "intangible asset".

Now it would appear that the preferred vehicle for financial speculation has had a generational reset. Gold was the king of the hill for my generation's era. No longer. The yellow metal, sometimes known as the "archaic relic", looks like a non-starter when it comes to speculation with the Ed Sheerans and Taylor Swifts of this world.

Bitcoin, the new incumbent version of gold, has now taken over the mindset of a new group of tech savvy speculators. This recent interest in alternative currencies is a valid example of disruptor economics. It's no wonder Bitcoin has now surpassed the market cap of Paypal, a more traditional, institutionally facilitated payment system.

Bitcoin, and more likely Ethereum are here to stay as much as Uber and Lyft are. Get over it Gartman. The benefits of cryptocurrencies are real. But now the risks have grown commensurately with the price.

The problem is obvious. How can you encourage adoption of a currency when the value can change so abruptly overnight. Back in 2010, Florida programmer Laszlo Hanyecz talked someone into accepting the 10,000 Bitcoins he'd "mined" on his computer in exchange for two pizzas. Within a month of doing the deal, the value of Bitcoin had risen tenfold. The current value of the this once lowly zah is currently close to $40mm. Well at least it had double pepperoni.

So the economic usefulness of the e-currency model is actually being destroyed by it's success. But speculation is ultimately self-correcting. The basic advantage of Bitcoin is that it is limited to a maximum issuance of 21 million units and not controlled by any government. That advantage is negated by the low barrier to entry of competing, and in the case of Etherem, superior technologies.

As I write this, the value of Bitcoin is down 15% in a matter of hours. With traditional currencies, a notable intra-day move is 1.5%. I believe it will take many years for it to fully establish cryptocurrencies' validity as a medium of exchange for payment. They need to stay stable to become widely accepted as a store of value. Speculators will need to be burned many more times before that reality sinks in.

Risk Model: 3/5

The Rsi and Bull/Bear ratios are marginally in sell mode but the rapid spike in Vix has reversed quickly enough to keep the model in a mechanical risk-on position. Gold is losing its haven bid after the North Korean bump reversed.

The market has begun to lose breadth, as the Transports, Energy and Small Cap are not acting well. Fang is in the early stages of correction mode as well. Given the competition for expensive content, the loss of Netflix from this popular acronym would be unsurprising (as well as not very politically correct). Apple should peak around the iPhone 8 launch.

The Retail Sales print this morning, along with Dudley's hawkish comments have propelled rates, and therefore banks, higher. The Value/Growth chart needs to turn quickly here to sustain the rotation and extend the rally. Energy looks especially sick going into the seasonally weak fourth quarter. Copper and Iron Ore are correcting after a strong run.

With so many cross currents, index players are struggling and momentum based active management is gaining ground as a strategy.