Bitcoin Bubble

Today is the first day of futures trading of bitcoin. The bitcoin phenomenon has been going on for years, but the price appreciation in 2017 has caused investors to sit up and take notice.

The so-called cryptocurrency has soared over 1,500% this year.

Following its origination in 2009, bitcoin was viewed as a black-market currency among groups of programmers. After it began trading in April 2010, it is reported that Florida programmer Laszlo Hanyecz conducted the first bitcoin transaction when he paid 10,000 bitcoins to get two pizzas delivered from Papa John’s.

Today those bitcoins would be worth $160 million! Hanyecz has reportedly said that he’s not upset—the pizza was really good.

At first, bitcoins traded largely under 14 cents, but by February 2011, they achieved parity with the U.S. dollar. Early this year, they had topped the price of gold!

By that time, bitcoin’s persona had shifted to a store of value against the threat of inflation and devaluation of a nation’s currency. But this year it morphed into a new identity as a truly speculative investment vehicle.

It seems like everyone is acquiring a bitcoin “wallet” and “investing” in the relatively new currency. Somehow they have ignored the fact that fraud and computer theft has victimized many of its users. It is dependent upon its decentralized origination, but that can be a security weakness, as are the online wallets that have to be safeguarded.

Just last week a bitcoin processing firm reported that more than $64 million in bitcoins were hacked from its accounting system. Reuters reports that “More than 980,000 bitcoins have been stolen from exchanges, which would be worth more than $15 billion at current exchange rates. Few have been recovered, leaving some investors without any compensation.”

The coin’s mining system and underlying algorithm seem secure. But the storage or wallets seem very vulnerable.

In addition, its historical volatility seems to have been ignored as the bitcoin story has been told and retold around the world. Lost is the true tale of how the coin topped at almost $30 in 2011, only to fall to just over $2 in a matter of months. Since then, plunges of more than 50% have been recorded. Just last week the price fell 25% in one day (equivalent to the 1987 stock market crash) before stabilizing around $16,000 per coin.

This currency has been called a collective Ponzi scheme. It has been largely viewed by economists as being in a bubble phase … and bubbles pop.

One look at the chart this year seems to confirm the bubble theory. It looks a lot like the Tech sector did just before it plunged 75% beginning in March 2000.

BitStamp (USD)

And now there is the news that futures trading has commenced. Next week it will expand to another commodity exchange. Even the stock exchanges are talking about trading it.

One of my favorite market gurus, Jeffrey Gundlach of DoubleLine Capital, came up with an apt analogy. When uranium became a popular investment in the early 2000s, the futures markets took notice, and on May 6, 2007, the futures market initiated trading in yellowcake uranium futures. The following chart tells the rest of the story.

Ux U308 Price - Full History

Beware … what goes up may come down.

Market update

The S&P’s climb since the depths of the financial crisis in March 2009 has not been as steep as bitcoin’s. But it has been impressive!

S&P 500: Current Bull Market

And the gain this year seems likely to be the third-best year of the eight-year bull market.

As remarkable as the chart is, I would resist comparing it to bitcoin’s “bubble.” Still, it does rank as the second-longest bull market and is in the top 10 in terms of its gains.

We are in the midst of what I call the “Clause Pause,” the period after the first week in December until the week before Christmas (December 5 through December 20 this year). It, however, does not suggest a serious decline but rather a sideways to down period in stock market prices. It certainly is not likely to precipitate the type of decline associated with the popping of a bubble.

This is not likely to happen in the near future. The market continues to trend higher. And our intermediate-term strategies remain bullish and fully invested.

In addition, major downturns in stocks are usually associated with recessions. At the moment, none of the early warning signals are showing signs of the onslaught of such economic chaos. When they do flip to warning or alert status, it’s usually at least six months before the economy actually turns lower. Experts are saying we are six to 18 months away from such an occurrence.

Still, we don’t need to have a full-scale bear market for investors to feel some pain. A 5% to 15% correction is possible, and I would say likely. The question, of course, is “when?”

Stocks remain overbought but only mildly so when compared to two weeks ago. Volatility remains under control at levels supportive of further stock market success.

If I were to guess what may precipitate a decline, I would speculate that the fate of the tax bill, whether it passes or fails, could do it. Or perhaps it will just be a beginning-of-the-year correction like we had in 2016. With most intermediate-term indicators remaining bullish, any decline seems likely to be short and shallow.

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