From The Desk Of A Trader #4
"It comes down to deeply understanding what you own as an investor and trader."
Today, we are happy to share the thoughts from the desk of a soft commodities trader. The following views are that of Martijn Bron and do not represent the views of his employer.
Mid March 2021 I wrote an article on LinkedIn called "Bitcoin from a commodity trader's perspective". I just read it again this morning after reading an article in the Financial Times from my former Cargill colleague Ivo Sarjanovic about commodities, crypto and their merit as an inflation hedge.
The article I wrote myself explains the essence of commodities price setting, and it answers what Bitcoin is from the perspective of a commodity trader.
In my very humble opinion, knowing what happened since early 2021 till today, my article aged very well. The price of Bitcoin collapsed by 50% since, many commodities rallied, the broad equity market indexes are about 10%-20% off from their all time highs, and many individual pandemic darling or non-profitable tech stocks have collapsed 80%.
If you want to learn about commodities and the functioning of markets really take your time to read it.
Human behavior plays a very important role in markets, but over time, economic fundamentals will always play out. That is the critical lesson everyone needs to learn, to know what to do when similar things happen in the future.
It comes down to deeply understanding what you own as an investor and trader.
Commodities are a very broad asset class, this is what the FT article is about. Not all commodities are good inflation hedges.
For each asset class you own, you need to deeply analyze its merit for your investment goals.
That requires time, skill, experience, dedication and determination. This is difficult, but trading & investing are difficult. That is the whole point.
Thanks Ivo and Alan Futerman
Bitcoin from a commodity trader's perspective
The internet is filled daily with discussions about what Bitcoin represents and what its price trajectory may be. I thought let’s give my perspective on what Bitcoin is, based on trading commodity markets.
In commodities trading, the purpose of price is balancing supply and demand. Commodities like iron ore, wheat, soy and cocoa reflect the cost of raw material for the production of goods which consumers demand. The higher the price of the raw material, the lower the demand for it due to the price impact on the limited purchasing power of consumers, and the impact on downstream producers’ processing margins. The extent of reaction of consumer demand to changes in price, so the price elasticity of the commodity, depends a lot on consumer categories, geographies and whether we are talking about consumer staples (like food) or non-essential consumer discretionary products (like a television). But the essence in commodities trading is, the higher the price, the lower the demand, over time. This sounds very logical.
Interestingly, with equities something counter intuitive happens, and even a bit jokingly it is said that equities represent the only product where the demand goes up when the price goes up. Think about that. This phenomenon is caused by the assumption that an uptrend in the price of the equity will sustain, and often by the fear of missing out of the opportunity from an uptrend, while “your neighbor” is getting rich. Equities itself have no tangible purpose, so there is no natural price elasticity linked to their usage like in commodities, and similar to Bitcoin you can say that equities have no intrinsic value, and are also digital (I own equities, but I will never see anything else than their price on my banking app). But equities represent the partial ownership of a company which is productive. If a company produces more value(able products or services) year after year, it is likely that its profitability rises year after year, which it will share with its shareholders, so it is very likely that the value of its equity, represented in its stock price, goes up, over time.
Now what is Bitcoin? I believe it does not have the characteristics of a currency. Whether it represents a store of value is for the financial market, and everyone who participates in it to decide for themselves, this is about trust and track record. What asset class does it represent to be able to be a store of value? Does it have the characteristics of a commodity, or of equity? The narrative is that the supply of Bitcoin is limited, which suggests it is a commodity, as the supply of equity by companies is unlimited, and the combination of limited supply and unlimited demand sounds like an interesting investment proposition, as it suggests that regardless of how high the price goes, no additional supply of Bitcoin is possible. The emergence of many other digital “coins” or tokens is already indicating that there is a reaction to price from the supply side though, which IS logical. The price behavior of Bitcoin seems to have the best characteristics of both commodities and equities. A rising price is increasing the demand, due to the fear of missing out, and as Bitcoin, like equities, and contrary to commodities, has no tangible usage in products, a higher price does not impact consumer purchasing power negatively through higher raw material costs. So the demand of Bitcoin is not rationed by price.
The limited supply narrative is a psychological trap, a marketing stunt, just like the reference to a coin, with nice visuals on YouTube. Bitcoin is a piece of math, a digital protocol, a code. If Bitcoin would only be traded in single units (coins), at the price of USD 60k, very little retail traders would (be able to) buy it. They would still be able to access it through leverage, but this is even riskier. I believe that demand for Bitcoin in single units at USD 60k would crater. Ask your neighbor invested in Bitcoin today, would you spend USD 60k on one Bitcoin? As you however do not buy Bitcoin in single units, which would make the supply due to the assumed limited amount of available units very tight, but in small parts of Bitcoin, you just invest in Bitcoin’s market cap, in a pile of money. And you can invest as much as you like, there are no limitations. So that makes the limited supply argument not comparable to limited supplies of tangible commodities like iron ore, wheat or cocoa. But that narrative of limited supply suggests you can compare it with physical commodities, and hence the narrative is that price of Bitcoin can only go up with demand outstripping limited supply. To retain access for retail traders in equity markets in case of too high individual stock prices, the stock will be split, like happened with the Tesla stock split in 2020, when its stock supply was multiplied by five and its stock price was divided by five. This is the same concept. Retail investors think the stock price is cheaper after a stock split, but this is just a psychological trap. Buying Bitcoin in minuscule parts of one unit is Bitcoin’s stock split.
There are a huge amount of people who are willing to gamble USD (a currency..) 5000 in Bitcoin, regardless of the price of Bitcoin per one unit. So the purpose which price has in commodities, balancing supply (stimulate supply through a higher price) and demand (ration demand through a higher price) is not properly functioning. The price of a commodity and equity is the ticker on the exchange or in the cash /physical / over the counter market. The value of a commodity and equity depends on who you talk to, always respect the person on the other side of the trade, but can be assessed/estimated basis generally accepted metrics (like financial ratios and discounted cashflow or other methods in equity markets, or planting, mining or drilling economics in commodity markets), which of course are subject to different interpretations and views about the future. In commodities markets we learn that farmers, miners, react rationally to price, and so do consumers, over time. The price of Bitcoin is the result of supply and demand of money flows, but its value, can it be explained? We hear value declarations of zero, USD 50k, USD 100k even USD 1 mln. Based on what?
As Bitcoin has no purpose, and Bitcoin’s price has no impact on the needed dynamic / ability to actually impact supply and demand, its value is anybody’s guess, and the greater fool analogy comes up very quickly. The higher the price, the bigger the fear of missing out, and the narrative is now following the price, rather than what happens in commodities, the price is following the narrative, or following the physical supply and demand dynamics over time. That narrative from Bitcoin evangelists has moved from Bitcoin being a currency, to being a store of value replacing gold, to a more easy to understand and attractive concept of now being a main stream asset class which everyone should have in their investment portfolio, professional and retail alike.
Alongside its price rally even stronger evangelical claims are now made about Bitcoin representing a new paradigm, the future of money, the best inflation hedge against global central bank money printing, whereby banks (“will become obsolete”) and governments have no more impact on the de-centralized digital currency Bitcoin which everyone will be using. The fact that the technology behind Bitcoin is hard to understand for most people (let your neighbor, or the taxi driver invested in Bitcoin explain it to you), and no one likes to be marked as old fashioned, missing the digital gold rush, helps to mystify and glorify the Bitcoin evangelists. The meteoric price rise is obviously proving them right, as the market is always right.
The narrative is now becoming louder and brought with extreme conviction by those who are all in on Bitcoin, they have all the interest to talk their book. Bitcoin is not about making life easier, so providing a great product which consumers need, not even that they don’t know yet they need, like the iPhone at the time it was introduced, and like many useful innovations. No one needs Bitcoin. Bitcoin is all about making money, it has become a highly speculative and extremely risky financial instrument, also with unclear counterparty risk, whereby it is very hard, if not impossible to determine its value alongside economic cycles. The evangelists who are already in, through Bitcoin or its derivatives ownership, or through benefitting from being part of its infrastructure (mining, the investment chain consisting of exchanges, ETF & derivatives issuers, trading desks), want you to believe differently, and lure you in on the promise of unlimited upside and riches for all. But the magic money tree does not exist. This time it is not different.
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