(Another) Crypto Crash

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Here are a couple of mainstream market quotes to ponder (and ridicule just a bit) as we kick off the week. Firstly, from the Financial Review:

Australian shares are set to open higher, bolstered by a late rally on Wall Street after a wild day of swings on concerns about the potential impact of omicron and in particular the impact of an extended pandemic on inflation.

Goldman Sachs, citing concerns about omicron, cut its forecast for US economic growth in 2022 to 3.8 per cent from 4.2 per cent.

“Our global economics team concluded that the ‘downside’ scenario — where the virus spreads more quickly but immunity against hospitalisations declines only slightly more — is the most likely omicron outcome,” Goldman said.

And from The Australian:

Bitcoin and other cryptocurrencies suffered steep declines — losing up to $500bn in value over a single day — as jitters over the impact of Covid-19’s Omicron variant rattled investors and sent them looking for safer ground.

The downward spiral for Bitcoin began on Saturday morning before gathering momentum after late-afternoon selling.

Between Friday evening and late Saturday afternoon Saturday, bitcoin fell from $US56,740 to $US44,800.

Last week, I wrote that I think Omicron is a sideshow compared to the main event, which is the Fed taper and subsequent tightening path.

The reality is that viruses mutate, and they mutate ‘downward’. That is, they don’t want to kill their host, so they become less severe, even though they might be highly transmissible.

I’m not suggesting Omicron isn’t going to pose some headwinds. From a psychological level, it will impact consumer confidence and spending. And there is always the risk of heavy-handed political responses.

But, on balance, if Omicron becomes the dominant strain, it will signify the beginning of the end of the pandemic.

Yet the media thinks it’s all about the new strain. Despite COVID being the best thing EVER for crypto, this new strain is apparently behind this weekend’s rout in prices.

Where’s the logic?

I’ll get back to cryptos in a moment.

Right now, though, the key thing to understand is that the market is reacting to the Fed tapering its ridiculous US$120 billion per month of asset purchases faster than expected. And ‘risk assets’, like cryptos and stocks with insane valuations, are taking it on the chin.

To me, at least, this makes much more sense.

That is, if you start to remove liquidity from the system (or promise to), assets that benefitted the most from that liquidity surge will begin to fall.

Cathie Wood’s ARK Innovation ETF [NYSEARCA:ARKK] is perhaps the poster child for the pandemic liquidity surge. It’s down more than 40% from its February peak and down 25% since early November. As you can see below, the chart looks ugly:

Ark Innovation ETF Price Outlook

Source: Optuma

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What’s more concerning for the insanely valued tech stocks is that falling bond yields are not offering support.

The argument used to be that low bond yields justified tech valuations via a low discount rate that put a high value on distant future cash flows.

But in the past few weeks, the yield on the 10-year US Treasury bond has plummeted from 1.66% to 1.35%. That’s the bond market saying the Fed’s rate hikes will lead to a slowdown next year.

It’s also a recognition of the coming fiscal tightening. The US budget deficit in the year to 30 September 2021 was around US$2.7 trillion, down slightly from a record US$3.1 trillion in 2020.

The Congressional Budget Office expects the deficit will fall to US$1.15 trillion in this (2022) fiscal year.

In other words, there will be a big drop in government spending this year. Will the economy be able to make up for that with a Fed keen to tighten?

These are the questions the market is grappling with. It’s not about Omicron.

Meanwhile, gold continues to impress here. I know the recent sell-off has disheartened many. But as you can see below, the chart still looks constructive and it’s doing this in the face of a very strong US dollar:

Fat Tail Investment Research


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Digital gold, however, isn’t looking as strong. This is hardly new ground for Bitcoin [BTC] and crypto, though. It’s par for the course. Volatility is the price you pay for the potential of massive outperformance.

I’m just a bitcoin observer, though, not a specialist. Here’s a brief excerpt from our crypto expert, Ryan Dinse, who had this to say to his subscribers about the weekend price action:

As you might be aware, crypto markets fell sharply over the weekend.

At one stage, Bitcoin [BTC] seemed to be in freefall. It was down 20% at one point, hitting US$42,000, before stabilising and rebounding to US$49,000.

Those falls in bitcoin brought down the entire crypto market, including our DeFi Index portfolio.

So what happened?

Basically, an important price level was breached by a big bitcoin seller — a so-called “whale” — dumping their coins quickly.

Because this happened in thinner, less-traded weekend markets, it had an outsized effect on price. A downside to the 24/7 market, I suppose.

In turn, a lot of leveraged traders — that is, people who borrow to trade using their crypto assets as security — were liquidated (forced to sell).

This process of liquidation cascaded down, causing a domino effect as prices kept falling, until the leverage was cleared from the system.

According to some stats I read, 372,000 crypto accounts were liquidated for a total of US$2.31 billion in forced sales. I’ll never for the life of me understand why people trade crypto on leverage.

Anyway, when the leverage was gone, prices stabilised and started to rebound.

While this might seem dramatic — and I know a 20% fall in one day seems extreme when you compare it to stock markets — remember in crypto this is fairly common.

Summing this up, I think what you’re seeing is the market pricing in liquidity withdrawals. That’s why the most liquid speculative assets are falling the hardest.

This may usher in a broader bear market as we head into 2022. But with interest rates remaining low, well-priced stocks that didn’t participate in the easy money melt-up this year should do reasonably well.

So depending on how you’re positioned, there’s no need to panic. But if you’re loaded up to the gills in speculative meme stocks, you may want to use any future rallies to lighten the load…


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Greg Canavan,
Editor, The Rum Rebellion

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Greg Canavan approaches the investment world with an ‘ignorance is bliss’ philosophy. In a world where all the information is just a click away at all times, Greg believes we ingest too much of it. As a result, we forget how to think for ourselves, and let other people’s thoughts cloud our own.

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