SX_volatility

Keep Calm and Carry On. Learn to manage the volatility of cryptos

Glenn Lawrence writing from Ronda, Spain

It’s going to be OK, really.

A crypto crisis does not mean the demise of crypto. The crypto universe is not ending. But the collapse of prices and the industry crisis offers important lessons, especially to newcomers to investing and trading who don’t have experience in other markets that periodically experience crashes.

The volatility of crypto is exceedingly high relative to other tradeable assets making this crash especially painful. Learning to manage volatility is crucial to success. And applying the lessons learned provides dual, complementary benefits: avoiding substantial losses when prices are falling and putting volatility to work for you to take advantage of crypto’s outsized profit potential when prices rise.

And, of course, if you are willing to short the market, you can take advantage of volatility to capture outsized profits when prices are crashing. Some recent quotes put the current crisis into perspective.

For example, in a story in Fortune, Mark Cuban, a crypto evangelist, especially of Ethereum (he calls himself an Ethereum “maximalist”), refers to an apropos quote from Warren Buffet: “When the tide goes out, you get to see who is swimming naked.” And, no doubt, the current tide is exposing a lot of naked swimmers. Cuban says, “Disruptive applications and technology released during a bear market, whether stocks or crypto or any business, will always find a market and succeed.”

Bingo.

This vicious bear market is capitalism working at its best. The bear market is good old creative destruction at work. The lousy business models tying up too much capital must go. It’s a market-driven reallocation of capital to successful surviving business models and new, improved models.

Many influential pundits claim that cryptos are a sham or Ponzi schemes based on the greater fool theory. But I say “not so fast”—these are easy claims for crypto haters to make.

All assets become overvalued, such as conventional assets like stocks in 1929 and the U.S. housing market in 2007-2008.  Those who buy “too high” also get exposed as “greater fools.”

The greater fool theory isn’t unique to cryptos. However, this train of thought leads to an interesting parallel. Remember the roaring “dot-com” days in late 1999 and early 2000? Forgive me, but most in the crypto space may be too young to remember that bubble.

This vicious bear market in cryptos reminds me of the bear market that followed the bursting of the dot-com bubble.

At the peak of the dot-com days, many were getting rich via IPOs with nothing much more than a business plan. Some were developing businesses that had just begun to generate sales but were not yet profitable.

For example, I have a friend who made millions via the IPO of a company that owned the twelfth-highest-ranked internet search engine. Who’s eager today to buy shares in an initial offering for the twelfth-highest-ranked search engine?

In another pertinent article, Rick Rieder, BlackRock’s chief investment officer of global fixed income, told Yahoo Finance Live, “You are seeing a lot of the leverage that was built up around crypto come unglued quickly. I still think Bitcoin and crypto are durable assets.”

Well said.

Market excesses are always a function of too much leverage and misallocated capital. Crypto as an asset class is here to stay. But much of the inefficiencies and excesses need to be cleared out.

It’s unfortunate, though, that the high amount of price volatility in cryptos makes this crucial period of creative destruction so painful. That’s a hard lesson for less experienced crypto investors and traders who haven’t lived through a bear market like this one.

That’s where Sovereign X’s SX Wealth comes in. You don’t have to lose your lunch riding the intolerable rollercoaster of crypto volatility.

SX Wealth’s philosophy is to play it smart; you don’t have to subject yourself to horrendous levels of volatility, and the corresponding doubt and anguish, to participate in crypto. Consider a lesson learned (usually the hard way) by the best traders of all time. Rule No. 1 in successful trading is to “cut your losses.”

Markets don’t always cooperate—it’s guaranteed that a market will viciously turn around on you at some point. Capital preservation is key. You have to protect your capital to take advantage of future opportunities. (For more of our guidance on successful trading practices, please refer to our user guides on the website.)

Beware that going “all in” on crypto in the past might mean getting blown up today. Please don’t do it.

Many leading cryptos with legitimate and productive business models have fallen 90% from their peak value in just over half a year. No one should have to endure that kind of risk, witnessing a 90% decline in the value of an investment. So how do you avoid painful downside volatility while preserving your ability to take advantage of bull markets?

First, you need guidance on when to step aside to avoid excessive risk and then when to step back in when conditions are favorable. That’s where SX Wealth | Crypto comes into play. We provide a variety of time-tested and proven models, many of which we have enhanced with our volatility adjustment technology, and we offer an objective synthesis of all of our models’ signals, so there’s no question about whether to buy or sell or how much capital to allocate.

Here’s an example.

Long-time subscribers are aware of our Buy and Sell Gauges. These gauges measure the aggregate of our trend models’ uptrend and downtrend signals. For instance, if all models signal an uptrend, the Buy gauge reads 100%. If half are signaling an uptrend, the Buy gauge reads 50%, and so on.

To show how well these signals have worked using our historical data, we are pleased to introduce historical charts focusing specifically on gauge readings.  Subscribers can now find three related charts on their dashboard to view the history of all of our models: buy signals from our Buy Gauge, sell signals from our Sell Gauge, and a chart that aggregates signals from both gauges. A relevant example for today’s discussion is presented below.

The chart of BTC’s Sell Gauge shows the daily price series of BTC in the upper chart window and the daily reading of BTC’s Sell Gauge in the lower window. When the gauge indicator is at 0, our models are not signaling a downtrend.  And when the gauge indicator is at its maximum of 10, it means all of our trend models signal a downtrend. A conservative approach to using SX Wealth’s gauges?  Act when the indicator is at 7 or higher (which equates to a 70% reading on a gauge). 

Notice that the chart has a purple horizontal line marking the 7 threshold. 

After BTC failed to rally in April 2022, the market entered the current leg of the longer-term downtrend.  Notice that in late April, our BTC Sell gauge rose to 7 (marked with the red arrow), and ever since that date, the gauge reading has been between 7 and 10.  A reading of 7 or above is considered “strongly bearish.” So why endure the pain of watching BTC lose almost half its value when by following our signal you could have been sitting in the safety of cash, preserving your capital for the next time our models turn bullish (as they inevitably will)? We invite you to view the history of our signals from our Buy and Sell gauges using these charts by signing up for a risk-free 60-day trial subscription to SX Wealth | Crypto. Your password-protected dashboard will provide you access to see how our signals have accurately reflected crypto market trends, specifically Bitcoin’s movements, both up and down.

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L. Glenn Lawrence is co-founder and managing partner of SX Wealth. 

SX_gold_inflation-1

So why is gold going down when inflation continues to rise? Real yields and gold revisited

L. Glenn Lawrence, writing from Ronda, Spain

With consumer price inflation raging globally, I thought it would be a good time to revisit an analysis I drafted several years ago. We addressed the effect of “real” bond yields on gold prices and developed a simple econometric model as an objective indicator of a fundamental driver of the direction of gold prices.

This year we improved the model.

For those not familiar with the concept of a “real” yield, here’s a simple definition: the real yield is the effective yield of United States Treasury bonds when adjusted for consumer price inflation. It’s an essential fundamental driver of gold prices.

When bond yields are not high enough to provide a reasonable return in excess of the consumer inflation rate, investors and traders tend to seek the safe haven of gold. Conversely, when bond yields are high enough to offer a generous return above the inflation rate, investors and traders leave the safe haven of gold and seek a conventional return on capital in assets like government bonds.

Gold is a commodity (or form of money if you prefer) that effectively has a negative return. Gold doesn’t pay interest or dividends. Gold owners cannot earn a rate of return on the capital used to purchase gold. And in larger commercial quantities, gold owners have to pay a fee to store their holdings. The storage cost of gold effectively becomes a negative return. Historically, when investors are afraid inflation will erode the value of their investments or fiat currency, they willingly pay the penalty of the negative return because they believe gold will protect their wealth.

Developing technical and econometric indicators based on the real yield is the key to monitoring whether investors will seek the safe haven of gold or will pursue interest-bearing investments. Let’s look at some examples of the real yield.

For ease of use and access to data and consistency of bond issuance, we use data from the U.S. Federal Reserve for the yield on constant maturity 10-year Treasury securities and the annual rate of the median consumer price index.

In a previous commentary, we analyzed the real yield threshold where investors and traders were incentivized to own gold rather than Treasury securities. We found that a range of between 2% and 3% (i.e., yield on Treasury securities of 2% to 3% greater than the annual rate of consumer price inflation) was historically the most effective pivot point. We chose a threshold value of 2.5% for the analysis.

We have since tightened that threshold to 2%. Historically, the real yield is typically 2% or less most when gold prices are rising. Gold prices are generally weak when the real yield is above that threshold. But there are exceptions to this rule, and we have added to our arsenal of econometric indicators to improve our fundamental modeling.

It’s not just whether the real yield is above or below 2% that matters—the prevailing trend of the real yield also matters. It can be argued that, in the modern financial world of “risk-on / risk-off,” the trend of the real yield is even more important than its absolute value.

An important case in point is 2013. The real yield was below the pivot threshold of 2% for the entire year yet gold prices were in a downtrend for most of the year. But what also occurred in 2013 was that yields on U.S. Treasury securities were rising and outpacing the rate of inflation, driving a solid uptrend in the real yield.

It didn’t matter as much whether the real yield was below or above 2%; what mattered was that the real yield was improving rapidly. The uptrend in the real yield led to optimism on the part of investors and spurred them to sell gold and buy U.S. Treasuries.

Let’s look at the example of 2013 and then compare it to today’s market.

Figure 1 presents a chart of the real yield in 2013 (blue line). Notice that the real yield was generally moving higher for most of the year. Remember, gold is not an attractive investment when the real yield is trending higher.

We have developed an indicator to track the trend of the real yield, which is the green line on the chart in Figure 1. Notice that our trend indicator headed higher for most of the year – this is a strong signal not to buy gold during that period.

Figure 1

 

In the next chart in Figure 2, we add the price of gold to the first chart, represented by the price of GLD, a leading gold exchange-traded fund. Notice that GLD was generally falling in price while our SX Trend Indicator was rising (indicating that you should avoid owning gold). GLD fell over 20% during that period.

Figure 2

Next, let’s look at the past year’s real yield and our SX Real Yield Trend indicator.

This is the opposite of 2013 until the last few weeks. The downward trend in the real yield, which has been not just below the critical 2% threshold but negative in 2022, is precisely the kind of inflationary environment where investors tend to seek the safety of gold. The real yield is both far below the 2% threshold, and the trend has been firmly lower (meaning that U.S. Treasury security yields are performing relatively poorly compared to the surging rate of inflation).

How did gold perform in this environment? Gold rallied in the fourth quarter of 2021 and the first two months of this year as the inflation rate skyrocketed. Its strong rally was capped by a rapid move higher as an initial crisis reaction to Russia’s invasion of Ukraine. But what about the last few weeks? If inflation continues to be a problem, why has gold been going down?

The answer is that the trend of the real yield has reversed. The annual consumer inflation rate has declined slightly since January, while the yield of U.S. 10-year Treasuries has climbed substantially.

On the following chart in Figure 3, you can see that between early September 2021 and early March 2022 our SX Real Yield Trend indicator was heading lower, which is a buy signal for gold. And indeed, GLD moved higher. But beginning in the middle of March, our SX Real Yield Trend indicator started trending high, which is a sell signal for gold, and indeed, GLD has started moving lower.

Figure 3

With this new development of the SX Real Yield Trend indicator, our econometric modeling includes both the 2% threshold for the real yield and, most notably, the trend of the real yield. You want to be a buyer of gold when three things occur:

Our SX trend models are signaling that gold is in an uptrend.
When the real yield is below 2%.
When the trend of the real yield is lower.

But when our SX Real Yield Trend indicator is in an uptrend, be careful owning gold because gold prices face strong headwinds.

We’re scheduled to roll out our SX Wealth Precious Metals advisory service later this year. Our service will include a combination of econometric and technical price models.  

Precious metals can be highly volatile. And volatility is one major reason why we introduced our SX Wealth’s VolatilityEdge™ technology,  powering and informing our first-to-market trading signals, trading indicators, and advanced trading analysis for crypto.

For more information, visit Sovereign X’s SX Wealth channel.