Are you ready for ‘exponential gold ’?

Monday, 6 November 2023

[1 min read]

Dear Reader,

The RBA meets tomorrow to decide whether to raise rates for the first time since May. With inflation staying too high, the central bank will more than likely raise the cash rate to 4.35%.

Does it need to?

Not in my opinion. Firstly, there is still plenty of tightening in the pipeline. Monetary policy acts with long and variable lags. And it is questionable whether more tightening will do the job.

Fiscal policy is the source of inflation right now, not monetary policy.

And government — both state and federal — continue to spend wildly.

The fact is that when fiscal policy is loose, monetary policy must be tight.

So, you can put tomorrow’s rate hike down to the politicians spending you and your kids’ money.

It’s not just Australia spraying other people’s money around. US fiscal spending is out of control too. In FY23 (the year to 30 September) the federal deficit-to-GDP ratio was 6.4%. It’s forecast to hit 6.8% in FY24. This is crazy spending in a non-recessionary economy.

Perhaps that’s why Bitcoin is the best performing asset in the world this year?

With the huge supply of US bonds, investors are looking at alternative ways to protect their purchasing power. As Ryan Dinse points out in his essay below, the mainstream investment community now see bitcoin as a viable option on this front.

Perhaps you should consider a small allocation for your portfolio too?

[4 min read]

Dear Reader,

I’ve spent the best part of the past decade badgering people about Bitcoin.

I just can’t help myself!

As far as I’m concerned, it’s a better form of money for a fairer financial system. It levels the playing field.

And it also has the added advantage of being severely undervalued, in my opinion. If I’m right, the earlier you get off zero Bitcoin, the better off you’ll be in the future.

So, why wouldn’t I shout it from the roof tops?

In the early years, it was my soccer team mates who bore the brunt of my crypto evangelism.

I told them at training on a near weekly basis to buy Bitcoin from 2014 through to 2017.

It traded for as low as US$250 during this time period.

But as far as I know, only one person took me up on the idea and bought in (he bought 10 Bitcoins for the grand total of $6,000. Today that’s worth half a million dollars).

Then in mid-2017 I started my first public crypto advisory service.

With my friend Sam Volkering we launched the Secret Crypto Network — a mysterious name for what was still a mysterious asset back then.

We got a lot of people into Bitcoin at around $3,000 and Ethereum for around $250.

Since then, there’s been several raging bull markets and just as many earth-shattering downturns.

Price volatility has been the one constant. And that’s probably not going to change anytime soon.

But for much of this decade I’ve been a lone wolf in espousing the virtues of Bitcoin in the wider investment community.

I mean, none of my old colleagues in financial advice have ever recommended it. No super fund I know of owns any in Australia. The mainstream media still treats it as a criminal enterprise.

And even some of my own colleagues here at Fat Tail Investment Research have actively campaigned against it over the years!

However, in the past six months, there’s been a huge shift.

It’s happening slowly, but it seems I’m no longer a lone wolf in this.

Indeed, a growing number of mainstream financial institutions and analysts have done a complete 180 on Bitcoin.

And they’re getting louder by the day…

It’s off the charts

Check out these quotes from this month:

‘Money is about to undergo fundamental changes in the way it is created and used, potentially unleashing a dramatic re-ordering of the financial system.’

Oliver Wyman report, October 2023

I don’t own any Bitcoin…but I should’

Legendary investor Stan Druckenmiller,
24 October 2023

‘I like a barbell portfolio of cash and Bitcoin’

Mohammed El-Erian, former CIO of PIMCO,
31 October 2023

Interesting, eh?

But my favourite bit of analysis came last week from Head of Macro at Fidelity, Jurrien Timmer.

He wrote:

‘Bitcoin is volatile but its scarcity and adoption curve create the potential for it to be a high-powered hedge against monetary shenanigans. I think of it as “exponential gold.”’

‘Exponential gold?!’

That’s sure to make some ears prick up…

Timmer shared this chart to back up his claim.

What you’re looking at here is the correlation of Bitcoin’s value against its user base.

The black line is Bitcoin’s market cap and the red line is the number of ‘non-zero’ addresses holding Bitcoin.

This is on a log scale, so the figures rise exponentially.

You can see the clear correlation.

The more addresses holding Bitcoin, the higher in value Bitcoin goes.

Interestingly enough, right now the price is lagging this adoption metric. But that’s happened in previous cycles too.

If the cycles repeat, we could be in a for a ripping 2024 as valuation bridges the adoption gap once more.

But Timmer also shared a few other interesting data points in support of Bitcoin.

Let’s start with this one:

This shows different asset classes measured by their risk and return profiles.

Where’s Bitcoin, you ask?

It’s off the charts!

As Timmer tweeted:

As you can see, both the risk and the return on Bitcoin is huge.

But as Timmer points out the returns make the risk worth it.

He notes:

‘Yes, Bitcoin is down 54% from its two-year high, but it is also up 84% from its low. Government bonds can’t hold a candle to that risk-reward math, and neither can many other asset classes, at least at this moment.’

Anyway, he dives in deeper and actually comes out with a 50/50 Bitcoin/gold holding that rebalances quarterly as a very attractive strategy.

But none of this is news to readers of my Crypto Capital subscription. It’s the kind of thing I’ve been saying for years.

It’s one thing me saying it though, and another the head of macro at Fidelity saying it.

You see, there’s a professional snowball effect.

People like Timmer and Larry Fink over at Blackrock have spent the past six months legitimising Bitcoin as an asset class.

And it’s filtering down into the system.

For instance, check out this chart:

This shows the amount of open interest in Bitcoin on the CME exchange (a massive regulated commodity exchange in the US) has tripled over the past month.

That’s huge!

And it’s a growing sign of increased institutional interest in Bitcoin.

It seems to me it’s no longer a career risk for finance pros to start recommending some Bitcoin in their portfolios.

Indeed, it might start the case that it’s a career risk to NOT have some Bitcoin exposure soon!

Because here’s the thing about Bitcoin.

When the price starts to move, it can move very fast…

Supply shock incoming!

With a spate of Bitcoin spot ETFs potentially being approved at any time, demand could rise thick and fast.

While at the same time, the supply of new Bitcoin is set to fall dramatically in April 2024.

Today around 900 new Bitcoin is ‘mined’ every day.

In April 2024, this figure falls to 450.

At today’s prices, that’s just US$15.75 million of demand per day needed to soak up 100% of post-April new supply.

A fall from US$31.5 million today.

Remember too that 80.34% of existing supply (19.5 million) is held by what’s classified as long-term holders.

These are people who lived through the carnage of 2022 and stayed the course.

Believe me, you’re not going to part these types from their Bitcoin at these cheap prices!

It’ll take at least a break of all-time highs — a 100% rise from here to US$69,000 — for that to even start to tempt some, in my opinion.

And as I noted last week, the window of opportunity to front run this potential supply-demand shock is running out.

Are you prepared for ‘exponential gold’?

Good investing,

Ryan Dinse,
Editor, Fat Tail Daily

[5 min read]

Dear Reader,

Germanium and gallium may not be household names like gold or silver, but in the high-tech domain, they act as unsung heroes.

Sadly...China completely dominates them.

We use these metals in semiconductors for our computers, cars, medical equipment and military.

Semiconductors are quickly becoming the lifeblood of industry and metals like these will determine the winners and losers of our future.

China has also included Graphite in its list of restricted minerals, a mineral crucial for our EV batteries.

With these restrictions, China limits our ability to compete with its homebuilt EVs and take steps to move away from fossil fuels.

Looking at the full list of bans, we can see China wants to hold the keys to our future.

So why not just change to another metal for our semiconductors?

Well, apart from their roles in semiconductors, these metals also have unique applications.

We use Germanium for specialised camera lenses and fibre optics.

It's found in military tech like night-vision equipment and infrared sensors on ships, tanks and missiles.

Gallium, and its hard-to-make cousin, gallium arsenide, plays a vital role in solar cells and radio frequency chips.

These can take higher temperatures and produce less noise, making them crucial for cell phones and satellites.

It’s also found a new role in cutting-edge chips used in EVs that operate 20x faster and charge 3x more quickly – while being half the weight and size.

So why did China restrict these metals and minerals, and what can we do?

Command and control

China is playing tit for tat with the US, ramping up its export restrictions on the grounds of 'national security'.

Its latest moves can be seen as a response to the US export restrictions to slow China's access to semiconductor technologies. Steps that China avoids in other ways.

Last month China allegedly stole the technology to make the chips and gave the thief a new job at Huawei.

So if our restrictions fail, how will China’s moves affect our industry?

In the grand scheme, the restrictions won't be catastrophic.

In 2022, the US and EU combined imported around US$190 million in germanium.

Meanwhile US producers last year imported approximately US$220 million of Gallium Arsenide for their chips.

If we consider their trillion-dollar trade balance sheets, it's a drop in the bucket. Thankfully, alternative countries like Australia do hold these resources, but it's still early days.

Analysts from Eurasia Group described China's export restrictions as 'a warning shot, not a death blow'.

But it's one we shouldn't ignore.

And it’s just one of the ways Beijing is showing it wants to exert more control over the global supply of resources.

Research shows the value of Chinese investments and contracts in metals and mining exceeded $10 billion in the first half of this year.

That's a 131% increase compared to last year.

China also holds a massive monopoly over the processing and refinement of these critical metals.

So how do we go about navigating this?

Friendshoring

While China's production capacity is vast, it is not the sole player.

Countries like Canada, Belgium, and Australia are stepping up their efforts to fill in the supply.

Similar efforts happened after Russia banned gas exports into Europe at the start of the Ukraine invasion.

In an effort known as 'friendshoring', Western-aligned countries are creating supply chains that leave players like China and Russia out in the cold.

When Australia released its critical minerals strategy this year, it noted that 'friendly' foreign investors would be welcome to invest in Australia.

Resource Minister Madeline King commented on the strategy, saying:

'Like-minded partners can build new, diverse, resilient and sustainable supply chains as part of a global hedge against concentration.'

We then blocked China from investing in many lithium and rare earth companies.

It seems lessons have been learnt from the past.

An overreliance on China as a trading partner is something Australia clearly wishes to avoid.

For us, the opportunity to develop our critical minerals is too lucrative to pass up.

Untapped wealth, known potential

Australia has been a heavyweight in commodities for decades.

But the new shift towards green and high-tech industries has opened the spotlight to Australia's potential.

This is nothing new to our readers, but it's worth understanding just how much we hold in reserves.

We see a similar story in Rare Earth Elements (REEs), which could fill these new supply gaps.

Ahead of the game on the ASX, we have players like Lynas Rare Earths [ASX:LYC] and Arafura Rare Earths [ASX:ARU].

But there is also a growing list of smaller hopefuls that cover the gambit of necessary resources for the future.

The metals of the future, like Neodymium, praseodymium and dysprosium, are still off the radar for investors.

But all will be critical for future high-strength alloys and advanced magnets for motors and turbines.

Looking at Australia, we can see the market is still young.

20 ASX companies seeking to produce rare earths are valued under $50 million each and most struggle to secure funding.

A good example of this is Northern Minerals [ASX:NTU]. The company aims to challenge China's 94% monopoly of dysprosium for use in EVs.

The company is trading at 3 cents with a market cap of just under $200 million. But even in its infancy, geopolitical players watch it keenly.

On Tuesday, the company asked the Foreign Investment Review Board to probe whether recent share buys were a covert attempt by Chinese interests to take control.

This comes seven months after Treasurer Jim Chalmers moved to block Chinese interests in increasing their stake from 9.81% to 19.9%.

But as we block these investments, little Australian capital is there to fill the gap.

The challenge for investors and miners is the difficulty of processing and the lack of transparency around pricing in the market.

Here the Australian government can do better. More investment must flow into this space.

Thankfully, we’re seeing some progress, with the Albanese government recently promising a $2 billion expansion to the critical minerals financing.

But we need to set bigger goals to capture the downstream processing of these resources.

The Final Verdict

China's decision to restrict these exports underlines its pivotal role in the global tech supply chain.

But the actual impact of the bans may be more symbolic than seismic.

Still, it’s a stark reminder that in the world of geopolitics and global tech supremacy, raw materials can serve as powerful pawns on the international chessboard.

The unfolding battle will test the resilience of the global tech sector in an interesting way.

It will also test the diplomatic agility of Australian and Western powers.

For investors, it opens the door to small companies that will capitalise on the changing landscape of supply chain, whether for geopolitical or environmental reasons.

In any case, Australia stands to benefit.

Regards,

Charlie Ormond,
Editor, Fat Tail Daily