“Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.”
― Warren Buffett
"Cryptocurrencies basically have no value and they don't produce anything. They don't reproduce, they can't mail you a check, they can't do anything, and what you hope is that somebody else comes along and pays you more money for them later on, but then that person's got the problem. In terms of value: zero."
― Warren Buffett
Most investors understand that bonds are valuable because the issuing entity promises to pay a certain rate of interest over time and then return your principle. Similarly, stocks are valuable because they represent a percentage ownership in a business and, more importantly, a corresponding share of the profits the business will generate. Stocks and bonds are productive assets. The underlying entities create societal value through their business processes and as an investor you are rewarded with a portion of that created value.
There are other types of investments that are not based on the productivity of an underlying entity. Gold is one example of a very old investment of this type, and cryptocurrency is a very new example. As a mathematical investor, I only invest in things that I understand. So what makes investments like gold and crypto valuable? Why should I expect these to provide me a return on my investment? The usual explanations of why gold and crypto have value fall into these categories:
It's rare, supply is limited.
It's a store of value, a hedge against inflation.
Because people think it has value.
Gold does have some productive value for jewelry and electronics production, but this value is a small portion of its overall market price.
Let's consider reason #1 - gold and bitcoin valuable because they are rare and supply is limited. There are many elements much rarer than gold that are valued much lower. For example, tantium is the rarest stable metal on earth. Like gold, tantium has productive use in jewelry, electronics, alloys, and other products. In spite of its rarity, tantium price is only about $50 per ounce. It doesn't make sense that gold's rarity alone would equate to its value.
How about #2, that gold and crypto offer a store of value and a hedge against inflation and other investments like stocks and bonds. 2022 has been a period of high inflation and declining stock and bond prices. The following chart displays the S&P 500 Index, Gold, and Bitcoin prices by week for 2022 YTD:
We can see that all three declined over the 2022 YTD period. Looking at the correlation between the S&P 500 and Gold:
Each dot on this chart represents a single week in 2022 with the price of gold at the time shown on the X-axis (bottom) nd the S&P 500 price on the Y-axis (left side). Clearly, the S&P and gold prices are fairly positively correlated.
Bitcoin and the S&P 500 are even more positively correlated:
Based on this analysis, over the most recent inflationary period, Bitcoin and gold did not act as stores of value or an effective hedge against the stock market.
So we land on #3 as a possible explanation of value. Gold and bitcoin have value because people think they have value. This is the driving force behind many crazes like the Tulip Mania of the 1600's and Beanie Babies in the 1990s. These types of "investments" are not suitable for the reasonable investor and are dangerously prone to having zero value once the belief in their value ceases.
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