KPMG’s bitcoin and ether purchase is the lead story, because The Dispatch holds itself out as a crypto-leaning weekly! The high January inflation reading and rising risk of a Fed policy errors are of equal importance. KPMG Canada did not announce the size of its purchase, but an accounting/advisory firm supporting crypto is still a big deal.
The Dispatch was not surprised by the high inflation print, as regularly readers would expect. We do, however, believe that bond markets are correctly pricing a policy error by a Fed panicking over inflation. The flattening of the Treasury yield curve accelerated after the inflation numbers and a negative yield curve has been a reliable recession predictor in the past. History will likely prove the 2021 actions of the current Fed as one of the biggest monetary policy mistakes.
Dispatch #4 on February 11th, 2022, has the following line up of stories:
- KPMG’s bitcoin and ethereum purchase
- Government seized bitcoin worth $3.6bn
- Inflation at 40yr high leads to both bonds and stocks selling off
- What is gold telling us?
- NFTs as loan collateral
KPMG’s bitcoin and ethereum purchase
KPMG Canada announced that they had purchased bitcoin and Ethereum for its treasury. They also claim to have purchased carbon offsets to keep the transaction carbon neutral.
However, the firm does not mention of how much was invested in these two digital assets, leading some to speculate that this was mostly a marketing exercise.
If it is indeed a marketing ploy, imagine how far digital assets have come for a big-Four accounting/consultancy to go down this path? Crypto is now a profitable sector, but it’s not like this announcement is without risk to a global organization that is in the business of trust (audit) and advice (consulting). This is another data point in the long-term metcalfe’s law-driven adoption curve. In the short-term, macro will dominate direction as the past few weeks have shown.
US government seized bitcoin worth $3.6bn!
This bitcoin was stolen in 2016 from Bifinex (when it was worth $71m), which was one of the dominant exchanges. As Chainalysis explains, ~120,000 bitcoins were stolen from Bifinex in 2016 and spread across 2,075 wallets address controlled by the hacker. The FBI has recovered 94,643 of that bitcoin. Wired Magazine has a detailed look at how the crypto assets were moved and which techniques were used to hide tracks.
It was always going to prove difficult to access the hacked bitcoin as those coins were blacklisted, as Coindesk explains. The arrested couple abandoned crypto assets in multiple exchange accounts, because those exchanges asked for additional KYC (Know your client) information. Those funds were then frozen. For crime nerds, the 20-page DoJ arrest warrant should be a thrilling read. It certainly had The Dispatch excited! One detail that highlights the difficulty of laundering illicit crypto assets is that the couple purchased a $500 Walmart gift card to spend their crypto billions.
This five-minute video statement by US Deputy Attorney General illustrates the extensive cooperation between the DoJ, IRS, Homeland Security and FBI to make this arrest. She also thanks private sector operators that helped the process as their KYC/AML procedures triggered red flags or froze funds.
Stealing large sums via crypto assets is nearly impossible
To The Dispatch, this event once again proves that stealing (or any illicit activity) and accessing large sums successful on blockchain ledgers is becoming nearly impossible. The statement below from the DoJ, supports our view.
This bust does not mean that individuals should relax on their crypto-asset security. If an individual loses (to theft or hack) a few thousand dollars, or even a few hundred thousand dollars, those will very likely be lost permanently. This is because the FBI, and the crypto community don not have the resources to act immediately to follow and track the stolen assets. Imagine calling up your local police department to report stolen crypto assets? They are ill equipped to handle crypto crime today. In the coming years, we hope that system will allow even small thefts and hacks to be quickly handled by authorities. This is not the case today.
Inflation at 40-year high leads to bond and stock selloff
January inflation came in higher than expected with headline CPI +7.5% YoY, and core CPI rose 6.0% YoY, as this WSJ article explains.
Regular readers of The Dispatch are familiar with our high inflation view, which we articulated in Dispatch #23 in July 2021. More recently, we pointed out that while headline CPI is near a peak, that core inflation that the Fed uses to drive policy decisions, is likely to remain well above target. The January report provides more confidence in that view.
Base effects will start to reduce YoY headline inflation from ~April 2022. We can also agree that the cars and trucks won’t be in shortage indefinitely. Additionally, rising rates and sharply higher prices are natural depressants of further price appreciation.
Core inflation will be sticky
Core inflation, on the other hand, will struggle to come down fast enough to be anywhere near the Fed’s 2.75% year-end target. Shelter, by far the largest component of core inflation index, did slow sequentially to +0.3% increase MoM from a run rate of 0.4%-0.5% MoM increases from September through December 2021. On the negative side, medical care services accelerated to 0.6% MoM increase in January, and it has a higher weight in the Fed’s preferred inflation gauge, core PCE (personal consumption expenditure). Core CPI and core PCE have traveled together more frequently than not.
Signs of inflation becoming more entrenched
There are increasing signs of inflation becoming more entrenched. Car insurers have just rushed through rate hikes to offset higher car prices (possibly temporary) and higher repair costs (likely permanent due to labor). Auto insurance is slightly over 50% of the weight of all autos in the CPI basket. Coke and Pepsico reported strong sales on price hikes, but profits fell because costs rose faster. Goodyear shares fell 27% this week following earnings. Results were strong, but they guided for weaker future profit due to surging costs. Tires will be a source of future inflationary pressure. As a personal anecdote, The Dispatch received a noticed of a 27% price hike for storage space from a local moving company.
This WSJ article discusses the many subtle attempts by companies to raise prices. Some of the measures, like smaller package size, are captured in the CPI calculation. Others, like “Covid surcharge” at restaurants or removal of free airport transport or free breakfasts at hotels might not make it into the CPI calculation. These are all signs that the world is likely headed to a structurally higher level of inflation. Instead of the sub 2% inflation of the past several decades, perhaps we are going to be in 2%-5% range, which the bond markets are NOT pricing today.
Core CPI and Core PCE index from 2000 to December 2021
Here’s a structural trend of how the indices have diverged over time. Pick the index that shows lower inflation, and you have more flexibility to stimulate the economy. Which politician or central bank doesn’t like that? Broadly, shelter weight in PCE is about half of what it is in the CPI basket, and this is offset with medical care weight more than double in PCE vs. CPI.
What’s the conclusion from all of the above?
The risk of a policy error by the Fed continues to rise sharply. The Fed is laughably behind the curve: We just had a 40-year high inflation print in January while the Fed injected $71bn of liquidity into the economy in the same month. Bond markets are starting to price this policy error risk with accelerated yield curve flattening following the January inflation release. A negative yield curve (the yield of a 10yr treasury falling below the yield of a two year Treasury Note) has been a reliable indicator of slowing growth, if not a recession.
Long term chart of the 10/2 Treasury yield curve. Grey bars indicate recessions.
What is gold telling us?
Gold is a well perceived inflation hedge, but more recently, it has also been negatively correlated to real yields calculated using TIPS. In 2021, despite CPI-based real yields turning very negative, the market-based real yields were essentially flat and gold performed relatively poorly in 2021. Market-derived real yields have risen sharply (less negative) over the past two months, but gold has not fallen in response.
Source: via Twitter
It’ll be interesting to watch if the current breakdown in correlation is due to elevated geopolitical risks or if gold is sniffing out other factors. What could be these factors?
- Real yields will drop later this year as growth slows and rate hike expectations ebb. The almost negative yield curve is pointing to this scenario.
- Inflation remains higher for much longer, which leads to both higher nominal rates and more negative real yields.
Hardly anyone is talking about the second scenario, with many participants, including The Dispatch, openly worried about slowing growth. Gold can perform strongly along with rates hikes, as the 1970s showed. There was no market-based real yield in the 1970s because the Treasury Department first issued TIPS in 1997. However, CPI-based real yields were negative then.
ETFs were the largest sellers of gold in 2021
Let’s end with a look at physical gold demand and supply in 2021. The table below shows the estimated demand for the past two years. The notable change in marginal demand was from ETFs. 2021 will prove the peak of exuberance when meme stocks and Ark ETFs dominated and money poured out of safe haven gold ETFs. The 2022 set up is likely to shift funds in the other direction.
With our cautious view on 2022, gold offers important insurance protection. Gold’s centuries-long track record is a differentiated source of monetary premium compared to digital assets. It is a complement to digital scarcity, not a complete substitute. Our allocation to the yellow metal has been useful buffer for client portfolios in 2022.
NFTs as loan collateral
Crypto native firms are starting to accept NFTs as loan collateral, pointing to maturing of this recent monetary asset. However, it’s fair to ask if this is a sign froth because the most valuable NFTs rose ~ 100x in 2021 and remain a highly illiquid asset class. Unlike the leading crypto assets, NFTs have not experienced a prolonged bear market that has stress tested price discovery. Furthermore, NFT market cap is just $16bn (2/10/2022), according to NFTgo, barely 1% of total crypto market cap. Lending against NFTs is a high risk venture to our eyes.
Stay safe and do reach out if you have any questions or comments about the material in this Dispatch.
Asi
Important Disclosures
| This is not an offer or solicitation for the purchase or sale of any security or asset. While the information presented herein is believed to be reliable, no representation or warranty is made concerning its accuracy. The views expressed are those of RockDen Advisors LLC and are subject to change at any time based on market and other conditions. Past performance may not be indicative of future results. |