Crypto Perspective 5: Uncorrelated Asset?
What is an uncorrelated asset? Quite simply, assets are uncorrelated if changes in one’s returns don’t affect the other. Perfectly uncorrelated assets have a correlation coefficient of 0, and, from an asset management perspective, are important because they allow money managers to diversify their portfolios effectively. Which is where Cryptocurrencies supposedly come in.
4. Is it a non-correlated asset?
Given their decentralized nature, and their independence from governments (although government legislation still affects Crypto holders/hodlers), the asset class should theoretically be an uncorrelated asset.
Unfortunately, that just isn’t the case.
1 year rolling correlations between BTC, SPX, Gold, and US 10y yields were calculated using the YoY returns of each asset class (using monthly price data) in order to get a longer term (and smoother) view of Bitcoin’s relationship with each.
As the chart of BTC and the S&P 500’s 1 year rolling correlation clearly illustrates, Bitcoin and US equities are, more often than not, highly positively correlated.
As a matter of fact, other than for a period of about a year from 2015 – 2016 where the correlation dipped sharply negative, both asset classes have remained positively correlated.
The opposite is the case for Bitcoin and Gold. While the correlation between both has flipped sharply a few times over the last 8 years, the tendency for both assets is to be strongly negatively correlated.
Finally, the 1 year rolling correlation between BTC and US 10y yields is a near mirror image of BTC vs Gold.
What can we make of all this?
Firstly, and most importantly, that relationships in financial markets always change. Even versus US equities, which Bitcoin has the steadiest correlation with, the coefficient still flipped from highly positive to highly negative once.
Relationships between market variables should never be taken for granted, and are rarely set in stone.
That being said, BTC and US stocks have a remarkably steady positive correlation, that is, they tend to rise and fall together. Of course, for those inclined toward categorization, this places Cryptocurrencies in the “risk asset” box. Although it must be said that categorizations tend to be subjective and nuanced, differing to each individual’s perspective.
More importantly, for the purposes of this discussion, it also means that Cryptocurrencies are not uncorrelated assets.
Their return profiles have changed together with the broader US equity market, at least for the past 8 years, and on the basis of rolling 1 year correlations. As long as these relationships hold, Cryptos cannot really be seen as an asset that diversifies portfolios away from broad market risk (beta).
Consequently, if traders or investors want to hold Cryptocurrencies in their portfolios, they should make certain that they are deriving some sort of utility from the asset class based on its other characteristics.
To be continued…
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