Bitcoin's Correlation with Gold: A Key to Its Store of Value Potential

Citi Research strategists have highlighted the significance of tracking the correlation between Bitcoin and gold, as it could provide insights into Bitcoin's potential as a store of value. The bank's recent report suggests that while cryptocurrencies have historically been driven by macro factors, particularly equities, this correlation is expected to decrease as the crypto market matures.

The speculative nature of cryptocurrencies, especially during "risk-off" events, may lead to elevated correlations with risk assets. However, Citi anticipates that a more transparent regulatory regime in the US will contribute to more idiosyncratic crypto price movements. As integration into portfolios becomes more mainstream and institutional adoption increases, longer-term volatility is likely to continue declining.

Cryptocurrencies were the only asset class to increase in market capitalization as a percentage of US equities throughout 2024, according to the report. Citi suggests that the correlation between crypto and gold is crucial to observe, as it could signal Bitcoin's potential as a store of value. However, the bank believes that the term "digital gold" is not yet fully appropriate due to Bitcoin's current tech/equity correlation and high volatility.

Bitcoin demand is much more driven by speculation and optimism for blockchain adoption, and its volatility remains quite high relative to other traditional financial assets. Spot crypto exchange-traded funds (ETFs) attracted significant interest in their first year, driving returns. This trend is expected to persist, especially with regulatory clarity and broader adoption, which could lead to diminishing macro correlations. Institutional investors are likely to increase their involvement in the wake of clearer regulations.

In terms of portfolio management, Citi found that including Bitcoin could historically enhance returns, albeit with increased volatility. Their Black-Litterman analysis indicated that expected annual returns of 8-15% align with Bitcoin allocations of 1-5% in multi-asset portfolios. Bitcoin and Ethereum share similar macro risk exposures currently but may diverge in the future due to their differing use cases.

Citi recommends price-based filters and rebalancing strategies, such as moving averages and quarterly adjustments, to help manage portfolio volatility. The strategists acknowledged that neither cryptocurrencies nor equities have served as effective inflation hedges, but trend-following strategies could still be valuable, given the speculative interest in cryptocurrencies.