Gold and Bitcoin Break the Rules: What's Driving the Unusual Correlation?

The correlation between Bitcoin and gold has increased significantly in 2023

by Faruk Imamovic
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Gold and Bitcoin Break the Rules: What's Driving the Unusual Correlation?
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The correlation between Bitcoin and gold has increased significantly in 2023, as detailed in a recent report by asset manager Fidelity. This development marks a departure from Bitcoin’s previous trend of an inverse relationship with interest rates.

Typically, rising global rates dampen the demand for risk assets like Bitcoin. However, in the past year, both Bitcoin and gold have rallied despite the increase in real rates.

Fidelity's analysis suggests a decoupling from established financial trends.

"But this past year, we saw a complete decoupling of this relationship as real rates continued to rise, with Bitcoin not only holding steady but then rallying," the report states.

This unexpected behavior has also been mirrored by gold, which has seen similar price patterns recently.

In 2023, gold's performance was notably robust, increasing by 14.6% in United States dollars. This was driven largely by geopolitical risks and central bank demand. Bitcoin, on the other hand, saw a staggering 156% gain over the same period.

Fidelity noted, “Historically, Bitcoin has been relatively noncorrelated to gold over the longer term, but recently has shown an increase in correlation as both have rallied”.

The Speculative Dynamics Behind the Correlation

Fidelity speculated that the increased correlation might be attributed to concerns over the United States’ growing fiscal deficit or anticipation of changes in interest rates.

They theorize that Bitcoin and gold are possibly indicating skepticism about the bond market's predictions or signaling anticipation of more debt monetization by the Federal Reserve. Interestingly, Fidelity's research suggests that Bitcoin’s price is more closely correlated with inflation in the money supply and various liquidity metrics, rather than consumer price inflation.

The investment company also highlighted the tightening supply environment for Bitcoin. Long-term holders of Bitcoin have reached an all-time high of 70%, demonstrating resilience in the face of significant price rallies.

“Even in the face of a 160%+ rally in Bitcoin, we have not observed these long-term and illiquid coins moving in response to the price to take profit,” the report added.

The Global Economic Context and Its Influence

The correlation between Bitcoin and gold in 2023 cannot be fully understood without considering the broader global economic context. Last year's economic landscape was shaped by multiple factors, including continued recovery from the COVID-19 pandemic, geopolitical tensions, and shifts in monetary policies by central banks worldwide.

These factors have had a profound impact on various asset classes, including cryptocurrencies and traditional safe-haven assets like gold. Increased inflation rates in many countries, partly due to expansive fiscal policies and supply chain disruptions, have led investors to seek assets that can potentially hedge against inflation.

This environment has set the stage for both Bitcoin and gold to become attractive options for investors looking to preserve value. The resilience of Bitcoin, in particular, suggests that it is increasingly being viewed not just as a speculative investment but also as a viable hedge against inflation, akin to gold.

Moreover, the growing acceptance and adoption of cryptocurrencies in mainstream finance, as evidenced by the launch of Bitcoin spot ETFs and increased institutional interest, have further cemented Bitcoin’s role as a legitimate asset class in the eyes of many investors.

This evolving perception has contributed to the alignment in the behavior of Bitcoin and gold in the face of global economic uncertainties.

Bitcoin© Getty Images/Chris McGrath

Recent Bitcoin Price Dynamics

The Bitcoin market experienced a noticeable dip following the approval of a spot Bitcoin exchange-traded fund (ETF), falling by 6.8% between January 11 and January 12.

This drop came after a 75% rally in the 90 days leading up to the ETF's initial trading. Traders are now debating whether this signals a shift to bearish sentiment, as the inability to break above $47,000 has raised concerns.

Some market analysts suggest that market makers and whales might have attempted to front-run the spot ETF issuers by buying ahead of the launch, only to face potential losses. Additionally, with the Bitcoin halving less than 100 days away, miners may feel pressured to sell some of their holdings, as evidenced by the highest miners’ outflow to exchanges in six years.

However, an examination of Bitcoin derivatives offers another perspective. The aggregate futures open interest has increased, indicating sustained investor interest in leverage positions. The BTC futures funding rate has stabilized, suggesting balanced demand for leverage among long and short positions.

This data implies that the recent sell-off was not primarily driven by retail traders using excessive leverage. Moreover, the put-to-call ratio for Bitcoin options volume has remained low, indicating a lower demand for put (sell) options.

This suggests that investors are not overwhelmingly fearful of a potential BTC price crash.

Understanding the Spot ETF Impact

Part of the confusion and subsequent price correction can be attributed to a lack of clarity about how the spot Bitcoin ETFs operate, including creation, redemption, and price formation processes.

The skepticism among traders has been fueled by previous false ETF approval alerts and the uncertainty caused by some brokers restricting investments in the sector. The recent dip in Bitcoin's price on January 12 might also be linked to traders reacting to unknown variables associated with the spot ETFs, especially concerning their operation after weekend pauses and potential volatility outside regular market hours.

This uncertainty, coupled with a lack of comprehensive understanding of the ETF's impact on the market, may have contributed to the fear, uncertainty, and doubt (FUD) driving the recent price correction.

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