Gold Or Cryptocurrency: Relevance And Suitability For A Retail Investor

Gold or cryptocurrency? This question seems to be on the mind of many investors of late. While both asset classes may have their merits and demerits, we are concerned with understanding their relevance and suitability for a retail investor. 

Firstly, why are we comparing the two? Well, both gold and cryptocurrency are considered as alternatives to fiat currencies and a hedge against currency devaluation given their limited supply. No wonder both asset classes have done remarkably well amidst the unprecedented global monetary and fiscal easing in response to the pandemic.

But cryptocurrency’s ascent over the last year has been steeper than gold and that's why this asset class has garnered a lot of investor attention, particularly from institutional investors. But this journey upward has been one of extreme volatility given that cryptocurrency is a relatively new asset class with fewer participants and a debatable intrinsic value, which makes it susceptible to large price fluctuations, speculation and Elon Musk’s tweets. This extreme volatility of cryptocurrency, the most recent one being a 25% crash, also puts a question mark on it potentially being an alternate form of money.

Gold too has had its ups and downs over the last year, but the volatility has been lower on account of its well-established and liquid market driven not only by investment demand, but also consumer demand. Thus, retail investors who unlike institutional investors have a much lower appetite for volatility and risks would have been better off investing in gold. Maybe that's why, after chasing higher returns and enduring big swings over the last few months, funds seem to be now reversing from cryptocurrencies like Bitcoin to gold as investors appreciate the reliability and stability of the precious metal.

Lack of regulation of cryptocurrency is another factor that should discourage retail investors from investing in the asset class as it exposes them to crypto exchange defaults and fraudulent activity. While cryptocurrencies are completely digital, web-based wallets are prone to hacking, exposing your crypto holdings to theft. There have also been instances of investors forgetting their account details and losing access to their holdings with no authority or regulator to bail them out. Moreover, the government of India is preparing to ban cryptocurrency soon which could make holding or trading in crypto illegal going forward. Since cryptocurrencies are a direct competition to state owned money, one can expect such moves from governments. Gold on the other hand trades in a widely authorized and regulated market, with financial gold instruments like Gold ETFs and Gold Mutual Funds having the added benefit of not being prone to fraud or theft.

Given that an investor usually holds a mix of asset classes in her investment portfolio, analyzing an asset class in isolation doesn't give the complete picture. So let's move onto the role gold and cryptocurrencies can play in a portfolio. 

As per an analysis by the World Gold Council published in February 2021, adding gold or cryptocurrency to a diversified portfolio would have improved risk-adjusted returns over the last 5 years. However, cryptocurrencies would achieve this through higher returns and not from a reduction of portfolio volatility. In contrast, gold, like a true diversifier, would not only add to returns through price appreciation but also lower volatility. Gold being a better portfolio diversifier than cryptocurrency is further highlighted by the World Gold Council that says adding cryptocurrencies like Bitcoin to a portfolio may warrant a higher allocation to gold as a way of managing the additional volatility. 

Gold's liquidity and negative correlation to equities during significant stock market falls helps investors manage risk in times of market downturns. The same cannot be said for cryptocurrencies. For instance, in the stock market crash of March 2020, Bitcoin ended the month ~25% lower in line with global equities whereas gold ended flat after an initial correction.

All in all cryptocurrencies seem suitable for sophisticated investors with higher risk appetite wanting to speculate and generate returns in the short term. Gold on the other hand is a strategic portfolio asset suitable for retail investors looking to protect wealth and generate long-term returns. Choose well.