Bitcoin Vs. Inflation
Bitcoin (“BTC”) has received a lot of attention of late, and many suggest that it can play a similar role to gold as a store of value and inflation hedge. In this short note, I’ll take a look at how BTC works in a “toy” portfolio with two other assets often used to protect against inflation: Gold and Treasury Inflation-Protected Securities (“TIPS”). Let’s call this toy portfolio the “Inflation Hedging Portfolio”, or “IHP” for short. We will use an equal-weight combination of the GLD and TIP ETFs as a benchmark.
To begin with, BTC does not have material correlation to the USD, Gold or TIPS. That suggests that BTC might play well with GLD and TIP in a portfolio by adding a bit of diversification benefit (see Illustration 1).
Bitcoin is very volatile, so any large allocation to BTC could drown out the returns of GLD and TIP unless we equalize the volatility of the allocations somehow (see Illustration 2). There are a lot of options for attempting to equalize the risk of diverse investments, but for this note we are going to use an arbitrary small allocation for BTC of 5%, and equal weights for GLD and TIP [47.5/47.5/5 for TIP/GLD/BTC]. In real life we would likely estimate risk over a short window or windows and rebalance frequently, but we will just use a static target allocation with monthly rebalancing here.
IHP has attractive returns and risk for the period we examine, and handily outperforms the GLD/TIP benchmark. While that is nice, the main reason we built this portfolio was to protect against inflation. Below we see that the portfolio has a strong, statistically significant negative relationship to the USD (t value: -9.181, p value: 0.0000, Adjusted R-squared: 0.2179). The benchmark portfolio of GLD and TIP has a very similar relationship to USD (t value: -9.579, p value: 0.0000, Adjusted R-squared: 0.2329). This suggests that either portfolio may have the potential to counter inflation. I’m not sure the difference is significant, but IHP does have a slightly less negative relationship with the USD than GLD/TIP.
We should of course be very wary of jumping to any conclusions. As Campbell Harvey and his co-authors point out; the sample is very small, and we do not have any observations of BTC during an inflationary regime. This quick analysis is not conclusive, but it does suggest that a little bit of BTC might give a boost to a portfolio of Gold and TIPS without materially detracting from the potential to protect against inflation.
Illustrations
- Correlation of weekly returns Jan 2015 — April 2021
2. Annualized Standard Deviation of Weekly Returns
3. Hypothetical Portfolio Performance
4. Hypothetical Portfolio Statistics
5. Hypothetical Portfolio Correlation Matrix
6. Scatterplot of weekly returns of USD Index vs. the “Inflation Hedge Portfolio”
References & Resources
- Sample R Code: https://github.com/rufusrankin/jff-btc-vs-inflation/blob/main/code
- Neville, Draaisma, Funnell, Harvey & Van Hemert, “The Best Strategies for Inflationary Times.” April 13, 2021 Version. From www.ssrn.com
- Bloomberg: “Bitcoin Is Displacing Gold As An Inflation Hedge.” April 8, 2021.
Data
- GLD and TIP price data from Yahoo Finance
- USD Trade-Weighted Index (DTWEXBGS) from FRED
- BTC prices from riingo/Tiingo
Disclaimer
This article is for information purposes only and does not constitute investment advice. Any opinions are those of the author and do not represent those of Ampersand, Drexel University or any of their affiliates.
