Nothing Goes Up in a Straight Line Forever

Nothing goes up in a straight line forever... A 54% drop in just 36 days... The most remarkable feature of bitcoin's plunge... What should you do now?... Upending my notions about inflation... The 'social mood' is a key ingredient...

Editor's note: U.S. markets and our offices will be closed on Monday in observance of Memorial Day. After this weekend's Masters Series, we'll resume our normal coverage on Tuesday. Enjoy the long holiday weekend.

It's one of the biggest no-brainer statements in finance...

Nothing goes up in a straight line forever.

It's true about stocks... Even though prices have consistently hit record highs over the past 12 years, we've seen a bunch of pullbacks along the way. Anyone remember last March?

It's true about gold... Since bottoming at roughly $1,050 per ounce in December 2015, the precious metal's value is up about 80% to $1,900. But it has also seen multiple 10%-plus pullbacks in that span. It fell almost 20% from last September through March, for example.

And most recently, this statement is proving true about cryptos.

Yet, judging from how a lot of folks are reacting to the crypto sell-off, it seems no one has learned anything from the past 9 million times this statement has proven true. Some people seem to think – yet again – that this is the beginning of the end for bitcoin and cryptos.

In today's Digest, I (Dan Ferris) want to explain why these folks are dead wrong... And when it comes down to it, you must remember why you bought bitcoin in the first place.

We've followed the rocky road for cryptos in recent weeks here in the Digest...

On May 19, we shared Crypto Capital editor Eric Wade's advice on how to handle the crypto pullback. And then, this past Wednesday, my colleague and Digest editor Corey McLaughlin linked a famous quote from legendary investor Warren Buffett to the opportunity in cryptos.

Bitcoin looked as wonderful as any asset in mid-April... The crypto's value was rapidly rising as it hit an all-time high of more than $64,000 on April 13 and pushed toward $65,000.

That was – for now, at least – the moment of maximum optimism...

Bitcoin's value started falling that day. It briefly hit a recent bottom of $30,000 on May 19. From peak to trough, that's a 54% total decline in just 36 days.

Bitcoin lost roughly $600 billion of market value in that span. The overall crypto asset market lost more than $1 trillion of market value from May 12 through last Sunday.

Some investors really got clobbered...

The South China Morning Post reported $10 billion in liquidations from May 19 to May 21. And the newspaper suggested that excessive leverage was to blame for much of that loss...

Crypto exchanges such as Binance allow as much as 125 times leverage. That means you can control 125 bitcoin by simply purchasing 1 bitcoin. That's insane.

When you use 125 times leverage, a 0.8% price drop in the asset wipes out all your capital. That's not investing. I wouldn't even classify it as trading. It's pure gambling.

If you were one of those levered-up gamblers, you took a serious loss and maybe even got totally wiped out. But otherwise, the most remarkable feature of bitcoin's price plunge was – as is the case in many economic matters – what you did not see...

By what you did not see, of course, I'm talking about everything that didn't happen...

No large financial institutions failed. The Federal Reserve didn't have to bail anyone out. No catastrophic wave of margin calls occurred. No industry collapsed. No mass layoffs were announced.

Dozens of books will not be written, and movies will not be made about bitcoin's 54% plunge in a little more than a month. It won't change the course of history or terrify bankers from lending for a decade. (We'll get to more on that last point in a minute.)

A major – albeit very new – asset class lost more than $1 trillion in value in less than two weeks, and it wasn't really a big deal.

The speculators took a licking... and the system just kept on ticking.

If this type of sell-off hit the bond market, you would see 2008 calamity to the 10th power – possibly even societal breakdown. And the same thing if it happened to the stock market...

Can you imagine the benchmark S&P 500 Index losing 54% in 36 days?

Last March, the S&P 500 plunged 34% as COVID-19 lockdowns devastated global economies. That was the biggest economic contraction since the Great Depression.

It makes you wonder what sort of "Greater Depression" would follow a 54% plunge in a little more than a month. (And remember, millions of Americans are still out of work from the initial collapse.)

When the stock market tanks like that, it nearly always correlates with serious economic damage. That's simply not the case with bitcoin and cryptos.

Of course, this brings us to the other side of that argument...

Since bitcoin's fall didn't matter, crypto skeptics might say that means bitcoin itself doesn't matter...

I don't see how you can say that, though...

JPMorgan Chase (JPM), the biggest bank in the U.S., has decided to offer bitcoin and other crypto assets to its clients. And so has BlackRock (BLK), the world's biggest asset manager.

PayPal (PYPL) has effectively made bitcoin payments available to its 348 million customers and 29 million merchant accounts worldwide. And even if Tesla (TSLA) founder Elon Musk wants to switch sides and not accept bitcoin as payment for his electric cars anymore, it's still getting harder to find more major businesses that don't accept it than ones that do.

Bitcoin has become a major force in finance... The fact that it hasn't noticeably disrupted credit-card titans Visa (V) and Mastercard (MA) or the traditional banking system – at least not yet – isn't the point.

The point is... bitcoin is here to stay (and cryptos, in general, too). And another run-of-the-mill 54% drawdown in U.S. dollar terms won't hurt its long-term value, whatever that might be.

Maybe you think the recent 54% plunge simply proves bitcoin is a lousy store of value...

Drawdowns aren't fun... We can all agree on that.

But I'll also remind you that gold, art, and real estate have been excellent stores of value for millennia... And yet, they've all endured similar – or worse – routs throughout history.

Bitcoin is structured not to change much over very long periods of time – like all three of those traditional stores of value (land development projects aside, of course). And it doesn't pay a yield – just like gold and art (again, real estate is a slightly different story).

There's more to a store of value than whether or not its fiat currency-denominated price exhibits volatility. That's true for at least two reasons...

First, you must consider "Wittgenstein's ruler." It's a term that trader and author Nassim Taleb coined in his 2004 book, Fooled By Randomness. And here's the main point...

Unless you have confidence in the ruler's reliability, if you use a ruler to measure a table, you may also be using the table to measure the ruler. The less you trust the ruler's reliability... the more information you are getting about the ruler and the less about the table.

So with Wittgenstein's ruler in mind, I ask you this... Is it more accurate to say that bitcoin is measured in U.S. dollars or that U.S. dollars are measured in bitcoin?

Don't get too wrapped up in trying to answer this question... You'll run into Alice, the Mad Hatter, and an entire army of rabbits hopping off to appointments if you go down that hole.

As I've said before, knowing the right questions is 10 times more valuable – and likely less risky – than believing you have the right answers. Questions keep you thinking... Answers can make you complacent. And even if you find them, they're rarely what they seem to be.

Now, the second reason there's more to a store of value than its volatility in fiat-currency terms... The most enduring stores of value have all outlasted multiple currency regimes.

That's a function of how those assets speak to the human soul... It makes them timeless and eternally desirable.

People will always want great art, which speaks to the human imagination as nothing else can. They'll always love gold for many reasons, including its immutable nature as an inert substance. And they'll always value land, which represents their own place in the world.

And as I've pointed out before, many people will always want Ferraris, vintage guitars, great wines (for a while, at least), and other (perhaps less-enduring) stores of value. To some extent at least, stores of value are in the eye of the beholder... The greatest stores of value – like gold, art, and real estate – simply have gained the most trust over the longest periods of time.

I believe bitcoin is carving out a similar place in the human imagination, and it will likely be around for at least the rest of my life – if not longer. But I can't know that for sure until after it happens... and that day lies somewhere in the (hopefully distant) future.

Given that bitcoin is a product of technology, and the fact that technology can change rapidly... it's natural to wonder if bitcoin will even exist in 10 to 20 years.

But if it doesn't exist then... would it be because it failed or because it was the precursor to something better, perhaps something bitcoin holders saw or had access to first?

I still believe it's worth owning some bitcoin with money you can afford to lose...

See where it takes you...

We don't know the limits of the upside. The downside is however much you spend to acquire a position. A small amount limits risk and gives you potentially massive upside exposure.

Also, let's get this straight... Bitcoin's downside volatility was always there. We just didn't see it because we were too busy celebrating its upside volatility. It's exceedingly rare for an asset to exhibit that kind of ballistic upside without an equally dramatic correction.

As I said at the outset of today's essay... Nothing goes up in a straight line forever.

So what should you do with bitcoin now that it has plunged 54%?

Should you buy more? Should you sell? Should you just hold what you already own?

I can't make those decisions for you. I can only tell you what I'm doing...

I've never sold bitcoin. I bought a little more on Tuesday, increasing my position by 6%. I expect to keep adding to it in the coming months – and my Ethereum position, too.

I'm in no hurry, though...

The bitcoin and overall crypto market could move sideways for several months. When speculative froth gets thick, it can take time to return to bull mode after a sell-off. And with bitcoin rising nearly 10-fold from March 2020 to April 2021, I'd say the froth was super thick.

My good friend Jason Goepfert backed me up this week on his SentimenTrader.com blog... Essentially, Jason showed that bitcoin endured a rough several months after it was this volatile in the past. So I don't think we can expect an immediate reversal to the upside.

But again, as long-term investors, we're not going to throw in the towel for a little rough patch...

If you believe bitcoin is here to stay and that crypto assets represent an innovation on par with the Internet itself, you pretty much have to buy here – or at least continue holding.

Be careful putting too much meaning to short-term price movements in bitcoin, though...

I doubt its prospects improved 10-fold when its price rose that much from March 2020 to April 2021. And I doubt that they fell by more than half during its recent rout.

In the end, the volatility reflects the huge uncertainty about bitcoin's future... as well as the tendency for speculators to be way too optimistic about its prospects in the short term.

I would love to just leave it at that and end today's Digest right here. But it irks the heck out of me when a bullish call isn't filled out by also understanding the risks involved...

If bitcoin's future isn't as bright as its past price movement, we'll all look back with perfect hindsight...

We'll view the current time as being filled with classic signs of a massive bubble.

One bearish sign comes from Ray Dalio, the billionaire founder of Bridgewater Associates. It's the world's largest hedge fund, with roughly $223 billion worth of assets under management.

Dalio recently revealed that he owns some bitcoin. One source suggests that it's a grand total of six bitcoin, with a market value of roughly $217,000 today. That's walking-around money for a billionaire, of course... So let's not read too much into it.

But this is a potential anecdotal "sign of the top" based on a quote from economist Benjamin Anderson's 1949 book, Economics and the Public Welfare. As Anderson states...

The more intense the craze, the higher the type of intellect that succumbs to it.

A 10-fold move in one year qualifies as a very intense craze, and Dalio is certainly one of the higher intellects in the financial world. Whether you agree with his views or not, he has built a unique organization based on original principles he developed over many decades. (He even published them all in a massive 593-page book called Principles.)

What if bitcoin is an intense enough craze to overtake the guy behind the world's biggest hedge fund... who is arguably the most successful practitioner in that industry... which is an industry that prides itself on hiring the best and brightest humans on Earth and does deeper research than all other types of investment managers?

In the end, here's my take...

Dalio owning six bitcoin isn't a reason to sell yours. Instead, consider it a reminder that the only people making a big mistake with bitcoin are the ones who are either 100% certain that it's worthless... or 100% certain that it will replace the U.S. dollar within our lifetimes.

Both claims are equally ludicrous. That isn't because there aren't good reasons to support either side, but because all the good reasons in the world can't show you the future...

We can't know for certain what will happen from here. So buying bitcoin is as risky as not buying it. And since there's zero upside in not buying bitcoin today, I'm buying it.

Ultimately, the only credible prediction about bitcoin's short-term future is succinct. It's what J.P. Morgan said when asked for his thoughts on the stock market...

It will fluctuate.

As my Extreme Value subscribers know, I believe bitcoin's long-term fundamentals are excellent. I simply recognize that its short history creates enough uncertainty about its future to cause extreme volatility – hence, short-term "fluctuations."

So let's talk about a particular development that might cause bitcoin to "fluctuate" as the market learns to trust it over time. This one trend that a lot of folks are talking about right now could possibly cause bitcoin to soar over the next several years...

I'm talking about inflation...

Investors could struggle to decide whether they can trust the crypto to hold value when fiat currencies fall. Remember, bitcoin is seen as a possible inflation hedge mostly because its supply is tightly controlled, while the supply of fiat currencies like the U.S. dollar is not.

There are nearly 19 million bitcoin in the world today. And based on how it was developed, that number will top out at just 21 million – in the year 2140. Compare that with the roughly $3.7 trillion in new U.S. dollar bank reserves that the Federal Reserve created in the past 14 months.

And if you think you understand inflation, I invite you to think again. Hedge-fund industry legend Hugh Hendry upended my notions about the topic on this week's Stansberry Investor Hour podcast...

Hendry is brilliant. He demonstrates deep knowledge of history and global financial trends. And after our discussion, I believe he's one of the greatest raconteurs in all of finance.

Ensconced on the Caribbean island of St. Barthelemy, Hendry told me that inflation is defined by the "social mood." And I told him that I didn't quite get it...

Many people who have studied the subject wind up with some version of economist Milton Friedman's conclusion that inflation is "always and everywhere a monetary phenomenon." If you've ever heard someone say something like, "Inflation is too many dollars chasing relatively fewer goods and services," that's just a simplified version of Friedman's assertion.

In other words, inflation is a function of how much currency is in circulation. If too much money is created in too short a time, prices will rise relative to the currency.

That's inflation.

So what could Hendry possibly mean by saying inflation is defined by the social mood?

In a nutshell, the social mood refers to the willingness of bankers to lend money... and of borrowers to take risks investing it into new enterprises.

Hendry cited the example of the inflationary period of the 1970s... Inflation rose, bankers were happy to lend, and borrowers were even happier to invest and spend. Hendry likened the social mood of bankers and borrowers back then to a story about his neighbors complaining that his teenage children and their friends were partying and acting wild – including jumping from roof to roof – while he was out of town.

Back then, oil-rich countries in the Middle East earned U.S. dollars by raising the price of oil... then deposited those dollars in European and other foreign banks, creating what became known as the eurodollar market. Banks were eager to lend those new deposits out around the world, including to American corporations and households.

The loans were spent and invested by borrowers, creating more new deposits. Under fractional reserve banking, banks can usually lend $10 for every $1 of deposits. That's how most new money is created (not by the U.S. Treasury or the Federal Reserve). Those new loans are deposited and lent and deposited and lent... All the new money is invested and spent, and inflation ensued. By April 1980, prices were rising at an annual rate of 14.7%.

Then, Paul Volcker became chairman of the Federal Reserve in August 1979 with a mandate to crush inflation. He pushed the federal funds rate from 11% in 1979 to 20% by June 1981 in an attempt to crush what Hendry called the "social mood" – bankers' desire to lend, as well as businesses' and households' desires to borrow, invest, and spend.

Volker succeeded... His efforts ultimately pushed inflation down to 3.2% by 1983, and U.S. Treasurys up to rates as high as 15%. When investors can get 15% risk-free from the U.S. government, it's a lot harder to get folks to borrow money for new investments and more.

A recession ensued, and Volcker's Fed went down as one of the most politically unpopular ones of all time.

Today, according to Hendry, the Fed is trying to get the economy to party like his teenage kids...

It's buying the drinks, using quantitative easing to take bank reserves to historic highs... But the "banks have no appetite to lend." The COVID-19 crisis and even the memory of the financial crisis of 2008 are making many bankers feel like they still have a hangover.

Also missing today, Hendry said, is "the verve of the entrepreneur, the private sector commercial agents" excitedly putting large amounts of capital to work.

So in the end, by Hendry's estimation, we simply can't have inflation – or even very robust economic growth – without a change in the social mood. Things are different today.

I'm not sure I agree, but I take Hendry's argument seriously. And I can't do all of his comments justice here, either... Just listen to the podcast. It's one of our best interviews ever... and man, is it ever worth listening to. I've already listened to it twice myself.

When I asked Hendry the same final question I ask all our podcast guests, he cheated a little bit...

As I've explained here in the Digest before, my final question is always, "If you could leave our listeners with one thought today, what would it be?"

Though Hendry's answer meandered as they all do – which is great, because he always goes deep into any question you ask him – he started with a classic bit of wisdom. It's one that might even change the social mood if enough investors and entrepreneurs embrace it...

In the enterprise of risk-taking, never be fearful of being wrong. If you're fearful of being wrong, you're approaching it the wrong way.

That sounds like a great way to wrap up as we head into the Memorial Day weekend...

If you're buying bitcoin, remember, you're taking a calculated risk. You're risking (hopefully just a little) on bitcoin on the chance that it'll prove to be one of the great innovations ever.

Being fearful of the inevitable volatility of such a risk, according to Hendry's final thought, could mean you're doing it wrong. Do it the right way instead...

Don't worry about the gyrations. Remember, nothing goes up in a straight line forever. It's going to be a long, winding road to the top... not a rocket ship that shoots us to the moon.

And if you find yourself worrying too much, you might be risking too much. Or maybe your mood just doesn't match the enterprise. In that case, maybe bitcoin just isn't for you.

New 52-week highs (as of 5/27/21): Automatic Data Processing (ADP), American Financial (AFG), American Express (AXP), Crown Castle (CCI), Richemont (CFRUY), Commvault Systems (CVLT), Expeditors International of Washington (EXPD), Facebook (FB), Forum Energy Technologies (FET), GreenTree Hospitality (GHG), ICICI Bank (IBN), Coca-Cola (KO), Invesco S&P 500 BuyWrite Fund (PBP), VanEck Vectors Russia Fund (RSX), Sprott (SII), and TFI International (TFII).

If you own bitcoin, are you worried about its recent pullback? And if you don't own any, do you think this latest volatility proves your point? We'd love to hear what's on your mind over the holiday weekend. Tell us at feedback@stansberryresearch.com.

Good investing,

Dan Ferris
Somewhere on the road in Medford, Oregon
May 28, 2021