Fundamentals and Long-Term Predictions: Bitcoin and Commodity Metals

Jun 18th, 2017 by adminadam in articles, home
  • INTENDED AUDIENCE: Beginning to intermediate investors, technologists, cryptocurrency enthusiasts
  • READ TIME: 30 minutes
  • NOTE: This article is not intended as financial or investment advice. Be sure to do your own research or consult your financial advisor before making any investment decisions.

STARTING ASSUMPTIONS: COMMODITIES IN GENERAL

  • Commodities are generally volatile over the span of days, weeks, and months.
  • Over longer time-frames, reduced volatility and greater price stability may be observed. No guarantees, however.
  • Most natural commodities have a cyclical component, with periodic booms and busts. This can be seen in oil, gold, wheat, and so on and on.
  • Supply and demand for any asset can influence the price just as much as sentiment can.
  • Markets may appear or act in irrational ways even over an extended period of time.
  • Distortions of data which hinder your ability to make accurate predictions may arise from imperfect information, complex regulatory environments, or other factors.
  • Known or estimated scarcity in a given commodity may generally be viewed as “bullish” in terms of price fundamentals, although not everything that is rare fetches a consistently high price on the open market, certain collectibles for instance.
  • Macro-economic trend analysis and forecasting is difficult for many reasons, some of which are listed above. I would posit, however, that improvements in forecasting and prediction methodologies should proceed in lock-step with advances and refinements in Big Data and Machine Learning. For example, see: Orbital Insight, a satellite Big Data company which today offers Machine Learning-derived “actionable insights”. This includes everything from infrared-mappings of chlorophyll activity being used to predict crop yields to live-streamed retail activity tracking utilizing shopper car-count and traffic patterns.

STARTING ASSUMPTIONS: COMMODITY METALS

  • As far as commodity and precious metals specifically, I would first assume you already have some understanding of — or can imagine — how metals such as gold, platinum, and silver can be seen performing distinct functions in the different realms of industry, technology, and finance. For example:
    • Central Bank gold bullion reserves [finance];
    • Platinum in catalytic converters [industry]; and
    • Physical vapor deposition of silver for thin-film solar panels [technology]
  • Next, I assume you can appreciate that an American Gold Eagle Coin costing $1330 and a New Zealand Darth Vader Silver Coin costing $21 don’t compete for the same market segment. This is true despite the fact that both coins are well-engineered and are made of precious metals.
    • You would recognize that gold’s superior valuation over that of silver is strongly correlated to the abundance (or paucity) of each element in Earth’s crust. Specifically, 75 parts-per-billion of silver and 4 parts-per-billion of gold are thought to exist in aggregate, roughly an 18:1 ratio.
    • Additionally, you could differentiate between an “investment-grade coin” and a numismatic coin if asked to do so.

      Darth Vader 1 Oz. Silver Numismatic Coin (New Zealand Mint)

  • Finally, I would suggest that a long-term investor who is evaluating precious metal coins and bullion to add to his/her portfolio would most likely want to select coins with qualities such as name recognition and convenience (high fungibility and ease of transport and storage). Later on in the article, I will offer a few suggestions of coins that I feel meet these criteria.

STARTING ASSUMPTIONS: BITCOIN

  • You have at least a little understanding of how bitcoin and other cryptocurrencies can be employed for distinct purposes, each use-case arguably aligning with one of the following four categorizations:
    1. Store of Value
    2. Medium of Exchange
    3. Distributed Public Ledger
    4. Programmable Token Platform
  • Store of Value:
    • ‘bitcoin’ (the coin) is a deflationary commodity with, I perceive, a significant-yet-undefined amount of capital appreciation potential extending out into the future.
    • That only 21 million units will ever come into existence is axiomatic to the Bitcoin protocol and software.
    • Bitcoin’s monetary policy can best be described as “Asymptotic Money Supply Targeting” (AMST). In actuality, the total number of coins in existence will approach but never reach 21 million even on an infinite time horizon. See Nakamoto Institute commentary for more on this: “The Bitcoin Central Bank’s Perfect Monetary Policy
  • Medium of Exchange: With bitcoin you can:
    • Buy gift cards from Gyft to use at your favorite retailer
    • Buy precious metal coins and bullion from Provident Metals
    • Execute trades on 50+ financial markets using Whaleclub.co‘s online exchange
    • Send either currency-pegged or floating-rate cross-border payments using Coinapult
  • Distributed Public Ledger:
    • As per the design of the Bitcoin protocol, you can view and audit all transactions, and all blocks of bitcoin transactions, starting from the original “Genesis Block” generated on Jan. 3, 2009, and extending to the most recent blocks.
    • This transaction ledger is referred to as the “block chain”.
    • See: Wiki; Blockchain History.
  • Programmable Token Platform:
    • You could think of Bitcoin (the network) as a “distributed, peer-to-peer, cryptographic asset network with built-in APIs” in the abstract.
    • To unpack this a bit, individual bitcoins or fractions of a coin are discrete, transferable bits of data.
    • These transferable (and divisible) “units” are cryptographically secured using a keychain (private key) that you control.
    • As well as allowing you to exchange and hold these ‘value tokens’, the bitcoin network does three things to create a novel digital infrastructure platform AND asset-class. To give a concise summary is difficult, but these are the three basic things that the Bitcoin network does:
      1. It coordinates resources to form a consensus on which coins are legitimate and which transactions are valid. This ensures no one cheats by trying to “double-spend” their coins or make an infinite number of them.
      2. It checks that every user and node in the network is using the same copy of the rules that govern bitcoin interactions, like what types of transactions are allowed. The way the network is constructed serves to incentivize users to adopt a consistent set of standards. These policies and mechanisms, including how “mining” works, are defined in the Bitcoin Protocol Specification.
      3. While the consensus can shift over time to accommodate upgrades to the network, it is fairly conservative. However, its conservatism and consistency in design in effect form a solid technical foundation that facilitates construction of secondary network layers and new capabilities starting from simple propositions. For example:
        • An individual transaction input (token) can be given an arbitrary association, which is recorded and embedded in the blockchain forever.
        • This embedded information can be anything from a plain text snippet, to a link to code functions, to a simple URL.
        • “Jobs”, a.k.a ‘Smart Contracts’, can be built using such basic, logic-based building blocks.
        • Users and Developers can set up such Jobs to be run automatically under X, Y, or Z conditions.
        • In the most abstract sense, this could be equated to “running a virtual machine on Bitcoin’s Virtual Machine Network”.
        • Two other applications which are usable today are: Multi-Signature Wallets with shared, custodial control; and Blockchain Identity and ID Protection services. Respectively, see: Copay.io‘s “multi-sig wallet” and Civic’s free ID Theft Prevention service.
        • All of these so-called “Blockchain Applications” rely on A) Bitcoin’s consistent consensus rules and incentives; and B) its highly secure, publicly auditable, and most importantly unredactable ledger.

PURPOSEFUL SPECULATION: A THOUGHT EXERCISE

Having established these starting assumptions, my hope is that the reader would then be prepared to consider how the consumption and application of these tangible and ethereal resources may change over time. Might we now be able to consider use cases and comparisons that would have sounded ludicrous previously? My thesis is that over time, compounded by the pace of technological change, what is currently difficult to imagine becomes imaginable, which next becomes difficult or unwieldy, ultimately becoming economical, feasible; common-place and eventually taken for granted. For instance, few of those present at the dawn of the internet imagined or could have conceived of live-streaming high-fidelity video and audio to thousands of fans at once. My belief is that performing such brainstorming exercises — even when it results in mostly ‘bad ideas’ — helps the individual to visualize a possibility-space which they may never have otherwise done…

To start off, here is a fanciful scenario involving Biotech, Coordinated Nanobot Swarms, and P2P Cloud Computing:

  • Individual gold-infused nano-particles associated with specific atomic-bitcoin units enable adaptive and highly-targeted drug delivery to extinguish rapidly proliferating cells throughout the body of a leukemia patient.
  • This computationally intensive effort is orchestrated using heterogeneous compute resources leased from various locations around the world via an automated smart-contract bidding process executed on the OpenBazaar market clearinghouse.
  • During this process a whole-body map is also drawn, updating the previous records stored in a hashed-and-encrypted format in the blockchain, protecting patient privacy…
  • Simultaneously a perfect, auditable 4D recording of the whole procedure is generated to mitigate malpractice claim risk to the medical practitioners who are supervising the process.
  • Ultimately, the operation is a success; the patient walks away cancer-free the very same day.

Here is a starkly more mundane example using an analogy that highlights a trait that gold and bitcoin have in common:

  • Gold is to scarce physical resources as Bitcoin is to scarce digital resources;
  • Neither asset can feasibly be manufactured artificially or independently;
  • Neither asset can be generated or acquired though means other than:
    • physical resource extraction and refining in the case of gold; or
    • verifiable computational work doing SHA256 hash calculations; these are entered into a drawing every ten minutes for a chance to win the ‘coinbase’ lottery known as the bitcoin “block reward” (currently 12.5 BTC for each new block).

A somewhat plausible-sounding scenario, using bitcoin to record and track gold deposits in vaults:

  • A private bullion vault offers a blockchain-based recording and tracking service to customers who have gold delivery bars on deposit in their vault.
  • This service correlates and stores the individual delivery bar’s assay records, origin data and other identifiers in the bitcoin ledger, creating a permanent association with a specific bitcoin tracking token, which none other than the legal and rightful owner of the gold can control or use to track and audit their holdings.
  • Additional thoughts: physical asset tags, QR codes, and RFID chips could potentially be added to further improve remote auditing capabilities.
  • An extension of this: starting with this well-tracked physical gold and building off of a smart-contract platform like Rootstock, you could tokenize your bullion to use as collateral for new and risk-laden enterprises, or for the formation of (truly!) gold-backed derivative products, like malleable personal Exchange-Traded Commodity Funds, and so on.

A wild-sounding notion with unknown practicability: silver-atom spin-state CPU R&D with quantum compute resources leased using bitcoin:

  • Silver atom quantum spin states modulated remotely using quantum computing processor time, leased with bitcoin on-demand.
  • Use this to test and simulate novel arrangements of silver atoms.
  • Next, using the test data, design and build a prototype silver-substrate, meta-material CPU that will allow us to extend Moore’s Law for traditional Von Neumann architectures for an additional decade.

Any of the above speculative scenarios may or may not come to pass. Personally, I find it enjoyable to fit the various commodity ‘puzzle pieces’ together, to try and picture how the interactions between metals and cryptocurrency might affect the fundamentals over time. This is an exploration of edge-cases, really. So take the above with a grain of salt. In the end you will have to decide how much you want to embrace a more speculative, growth-minded approach to commodity investing vs. a more conservative, value-investor angle. Either way I believe diversification, periodic portfolio rebalancing, and long-term planning to be essential. In any case, make sure you know why you are investing your hard-earned money, whether it be in commodities, equities, real estate, art, or otherwise.

I will say that one of my strongest convictions, though, is that the ‘all-cash position’ is unwise and will lead to successively less purchasing power for the ‘under the mattress’ investor. At the very least, if one feels uncertain about equities, bonds, interest rates, the state of the world… I believe an allocation to gold and silver of at least 10%, whether the rest is all in cash or not, should lend stability and optionality to an individual who is fearful or ‘excessively risk-averse’.

Now that we’ve explored a variety of speculative scenarios and fundamental investing principles, let’s get back to basics.

BACK TO BASICS: MY APPROACH TO PRECIOUS METALS

Gold has stood the test of time as a store of value. This should be well-known and understood to the reader already. For thousands of years humans have relied on gold’s scarcity, fungibility, and material properties to protect and exchange wealth. To me, gold is a great hedge against inflation and rising interest rates, which might degrade the performance of otherwise high-yield, fixed-income investment vehicles like bonds. Gold has limited upside potential, I believe. Although having gone through the thought exercises above, I am sure you could envision new uses for gold and other precious metals emerging over time; perhaps interacting in a nexus with bitcoin and other crypto-assets.

One way in which the Gold-Bitcoin Dynamic can be explored presently is with the Vaultoro Exchange, where users trade gold and bitcoin directly, with no settlement to USD or any other fiat currency at any point. It is a full-reserve service and exchange, with storage of gold in private Swiss vaults, fully attributed to the customer. The exchange operates continuously, 24/7/365.

Vaultoro represents a sophisticated offering in our day in my view. However, in the future I can imagine exchanges like Vaultoro taking a greater variety of forms, with expanded feature sets. For example, I could see such exchanges offering margin-trading, partial or shared ownership of assets, more automation and scripting options, etc. To experiment with the current offerings and gold-bitcoin exchange features might allow an individual to better conceptualize subsequent iterations and evolutions of such combined metal-and-crypto platforms.

Ultimately, whether you store it in private vaults or at home in a safe, gold remains a viable option for maintaining wealth over the span of 5 to 10 to 20 years in my mind.

A few of the physical gold products which to live up to my personal standards for convenience and name recognition include:

  1. American Gold Eagles (1 ozt. gold coin; ~$1330 currently)
  2. South African Krugerrands (1 ozt. gold coin; ~$1285 currently)
  3. Canadian Gold Maple Leaf (1 ozt. gold coin; $1290 currently)
  4. The 1/4 ozt. sizes of any of the above, which at ~$350 per coin are more affordable for those just getting started in investing
  5. Any National-Mint One Kilogram Gold Bars (1 kg gold bar; ~$40,800 currently)

Silver has served most often as a reliable smaller-denomination currency coin or ‘bearer instrument’. Silver’s importance in industrial, healthcare, and technological realms is unmatched. Copper emulates some but not all of the properties of silver. As a result of this, silver will likely always be an essential commercial and industrial commodity. Many investors and silver-promoters present a theses concerning “the eventual and sudden collapse in the supply of silver”, which some speculate will result in huge price appreciation. For example, some people will tell you that the silver price, under disastrous or critical-supply scenarios, is poised to jump from ~$17/ozt. to a price northwards of $80 or $100 per ounce. I can’t speak to and don’t necessarily endorse these views. However, I do think that the possibility of a supply-collapse resulting from an uptick in industrial consumption of the metal, combined with dire economic data and rapid inflation, should be considered. I like to think of it as a risk with unlikely probability but high impact. At this point, I would generally echo the notion that an investor looking to maintain his or her wealth through precious metals should likely only take on a position combining gold and silver of 5% to 10% of the portfolio at most. Remember that precious metals can be quite volatile themselves.

Some questions to consider in forming an allocation target for silver in your portfolio, should you choose to do so, are:

  • How much liquidity do you expect you will need in an emergency or a sudden economic downturn, knowing that some of the more popular silver coins are probably easy to sell for around $15-20 a piece at any local coin shop?
  • Are you bullish on the fundamentals of the metal for industrial and technological uses; do you expect to benefit from capital appreciation by investing in silver?
  • Do you have another reason, aesthetic, diversification-related, or otherwise for wanting to own silver?

My favorite investment-grade physical silver products include:

  • American Silver Eagles (1 ozt. silver coin; ~$19 currently)
  • Canadian Silver Maple Leaf (1 ozt. silver coin; ~$19 currently)
  • Silver One Kilogram Bars from reputable vendors such as Asahi, Geiger, Apmex, Valcambi (~$570 on average)

As an aside, my favorite numismatic silver coin is: the Austrian Maria Theresa Thaler, minted continuously starting from the mid-18th century. It typically carries only the symbolic year of 1780 to commemorate the end of Maria Theresa’s reign as Empress of the Austro-Hungarian Empire.

ASSESSMENT OF OTHER METALS: PLATINUM, PALLADIUM, COPPER

I am somewhat curious about Palladium, having recently learned via a Macro Voices podcast episode that this metal is poised to absorb some portion of the catalytic converter role that Platinum has traditionally performed.

Platinum is pleasant aesthetically; it’s very rare in the Earth’s crust, however I have no desire myself to own it as it looks no different than silver to the casual observer. Again name and visual recognition constitute my first requirement for “investment-grade metals”.

Copper is critical in infrastructure, healthcare, and technological realms. However, it’s value as measured in dollars has declined from roughly $4.00 per pound to around $2.50 per pound over the last 20 years.

I find looking at comparison charts and 20-year charts for these metals, gold and silver to be helpful. Here are three such charts from Provident Metals:

Source: https://www.providentmetals.com/spot-price/chart/gold/ (see also: comparison charts)

The 20-year performance trend breakdown and rankings for the five metals is:

  1. Gold UP 4X: $300 to $1200
  2. Palladium UP 3X+: $250 to $850
  3. Silver UP 3X: $5 to $15
  4. Platinum relatively UNCHANGED: $830 to $930
  5. Copper DOWN: $4.00 to $2.50

FUNDAMENTAL CAPABILITIES OF BITCOIN

  • Act as the arbiter of truth in situations where strangers and business partners cannot trust each other
  • Enable nearly-unlimited sum payments internationally that settle within an hour for a minimal fee, without the oversight or interference of 3rd parties like banks and remittance companies
  • Boot-strap and launch a store of value asset protocol based on mathematically-provable scarcity with ever-growing computing power used to secure said assets

My approach to evaluating Bitcoin based on its fundamental capabilities. I would ask myself these questions:

  1. The idea that blockchain records and other data can never be expunged or tampered with; how much is this worth to me?
  2. How might I be limited by either lack of banking/remittance infrastructure, poor customer service, high fees, the interference of middle-men in my financial affairs, etc.?
  3. On this note, am I comfortable being one of the first people I know to try out this new technological money system?
  4. To what extent do I believe various network effects are likely to keep Bitcoin firmly cemented in the dominant position in an ecosystem of rapidly-proliferating crypto-assets and alternative cryptocurrencies: Developer Mind Share; Store of Value Network; User Activity; Miner Hashing Power, etc.?

With the above questions as a starting point — and ideally with the speculative scenarios in mind to help calibrate your thinking nearer to the conclusion of your assessment of Bitcoin — hopefully you have a better sense now than when you started reading the article of how you can determine for yourself Bitcoin’s “Worthiness as an Investment”.

Thank you for reading and all the best to you!


Should you have any questions, feedback, or other inquiries, please feel free to email me at: 84adam [at] thrivenotes [dot] com


Further Reading: 

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