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Sunday, February 5, 2023

Is Bitcoin a Good Inflation Hedge?

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There hasn’t been a topic that has garnered more attention lately than inflation. Everything from used cars and groceries to gas and rent are much more expensive than just a year ago. This difficult situation is causing consumers to stretch their budgets and sparking fears of a looming recession as the Federal Reserve hikes interest rates. 

How should investors protect their portfolios? Let’s take a closer look at the very timely question of whether or not Bitcoin (BTC -0.75%) is a solid inflation hedge. 

What does it mean to be an inflation hedge? 

Traditionally, in times of rising inflation, investors turn to assets that they believe will increase in value in the near term to offset higher prices across the economy. For example, gold has historically been viewed as the most popular inflation hedge because it’s believed to maintain its value in times like these. 

The precious-metal’s track record, however, is spotty at best. In the early 1980s, at a time of high inflation, those who invested in gold lost money. But in the mid 1970s, another period of soaring inflation, gold produced stellar returns. An analysis from Morningstar found the correlation between inflation and gold over the past 50 years to be just 0.16. This means there’s almost no link. 

Even if we look at more recent data, the conclusion is still the same. Starting about a year ago, the Consumer Price Index, a key measure of inflation, began climbing at a fast clip. Massive government stimulus to combat the coronavirus pandemic, coupled with tight supply chains, resulted in an unexpected surge in consumer demand. But over the past 12 months, the price of gold is up less than 1%. This is a clear indication that most people’s belief of what an inflation hedge should be is seriously flawed. 

In my opinion, the definition of a true inflation hedge is any asset that rises in value greater than inflation over long periods of time. In other words, it’s all about raising one’s purchasing power. 

With this framework in mind, it’s clear that measuring an asset’s success at hedging inflation over a very short period of time is a futile activity, just like measuring an investor’s success over anything less than a decade would be useless. Time horizon matters.

Trying to move in and out of different financial instruments every month or quarter is a losing game that requires one to master market timing, which is impossible. Instead, owning the best assets for the long term is the correct approach. 

Bitcoin’s performance as an inflation hedge 

Based on the argument above that the true definition of an inflation hedge is an asset that increases purchasing power over time, it’s strikingly obvious that Bitcoin has absolutely thrived in this regard. Over the past five years, the price of Bitcoin has soared 687%, while the CPI has increased only 19% during the same time period. 

An investor who owned Bitcoin, as opposed to gold, would have grown their wealth at a fast-enough rate that makes inflation a complete afterthought. Sure, anything can happen in the near term. And with an asset as volatile as Bitcoin, wild price swings should be expected. But the numbers can’t be denied. If one wants to protect and grow purchasing power, Bitcoin’s performance in this regard is obvious. 

It’s worth mentioning that future returns aren’t guaranteed to resemble the past. And stocks or even gold could outperform Bitcoin in the decade ahead.

What’s important for investors to remember is that it’s all about increasing buying power over time. This mentality will help guide investment decisions that will benefit your personal financial picture and allow you to be critical anytime you see or hear what so-called experts say about inflation and how to deal with it. 

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