Hedge Fund Manager Paul Tudor Jones Bullish on Bitcoin
Legendary hedge fund manager Paul Tudor Jones, like the majority of investors, believed that gold was the best hedge against inflation. He’s changed his mind.
Paul Tudor Jones knows his stuff, and is not only one of the most famous hedge fund investors in the world, he’s also widely regarded as one of the best. A big part of the task of managing a hedge fund is the actual hedging part, and hedge funds are called that because they are allowed to hedge, in contrast to mutual funds which aren’t allowed to do very much of it at all.
Mutual funds are limited to diversifying within the segment that they focus on, a particular type of stock or bond for instance. They aren’t allowed to take anything but a long position in these assets, and can’t even lay low when times get tough as they have to be close to fully invested on the long side at all times.
This isn’t anywhere near as bad as it may sound, and it certainly doesn’t chain investors to these positions, even though many choose to. When these funds are desirable, we may desire to be in them, but there’s nothing obligating us to stay in them during times where they aren’t so desirable, where they are exposed to risks that they aren’t equipped to defend themselves from.
A hedge fund, on the other hand, can do virtually anything it wants, going either long or short, and not being limited to a single asset type either. Mutual funds don’t even stand a chance against a well-managed hedge fund, who can beat mutual funds both with greater returns overall as well as less risk, but they can also mess up and do worse, and even fail if things get too hairy.
Given that hedge funds have an open berth, sometimes they may take on way too much risk, and the way that they are structured does incent them to take on more than they would if they had to bear the losses of their bad trades like their clients do. Just like other types of funds, they differ in performance and risk.
This is one of the reasons why hedge funds are limited to those who are “accredited” investors, although we definitely wonder why income or net worth are the criterion. The income part makes a little sense, as if you get wiped out and your income is higher you may be able to recover a little better, even though people’s portfolios represent years of investing and you can’t just rebuild them that quickly if you get burned,
Using wealth as a qualification makes no sense though, and it should be seen as a bigger shame, not a smaller one, when someone who has money but no education loses it all. A more sensible way to accredit investors is to have them pass a course like people in the industry have to, and while the higher minimums that hedge funds generally require will keep more modest investors out anyway, at least those who do participate can be given some basic skills for them to at least be able to tell when a hedge fund manager is taking on way too much risk.
Hedge fund failures are very infrequent though, and with those that do go down, it’s not hard to tell they are acting too imprudently well before they crash, if you are watching and know what to look for that is, because hedge funds should be steering further away from these things, not toward them, because that’s what hedging is, hedging risk.
Investors who do not have the means to participate in hedge funds are left to their own resources when it comes to hedging, but with even a minimal understanding of it, they can do so much better than the hedge funds can. The example of how Ray Dalia got caught in the coronavirus collapse that we mentioned in a past article is an excellent example of this, as hedge funds are like mile-long trains that you just can’t get turned around very quickly or easily.
While individual investors can turn their portfolios around on a dime, funds simply cannot, because of their sheer size. They have to anticipate a lot more, and hedge funds are forced to guess more than we are, which is harder to do no matter how good you are.
Jones’ guesses are more than just guesses though, and you don’t have to do much guessing to spot the inflation risk ahead, something we’ve been talking about since the Fed lowered rates so much. Add in all those trillions in stimulus and there is going to be a price to pay down the road for that.
We’re not talking the effects of all that extra debt, as this roadblock is all about what happens when we stimulate the economy too much, and is the reason why central banks have tools to turn down the economy as well as up. With all that extra money supply, our money is worth considerably less, but in this case, we have to wait until the economy recovers and the money supply gets to where it will be when we’re back in business to feel the effects of this stimulus.
Few investors properly appreciate inflation risk, or even understand it all that well, and the idea of excess stimulus excites investors generally because they aren’t aware of why this is actually a bad thing. Think Donald Trump banging his fist for the Fed to lower rates at a time when it wasn’t needed and would have been a bad idea, even though it would have put stocks up more. Few investors even think of their assets in real terms, and instead just look at their nominal value, where they should be factoring in losses due to inflation and especially the big losses that high inflation can smack them with.
When we go on such a mass money printing spree like we have just done, one that is unprecedented, the value of our money gets diluted. Avoiding this is not just a matter of being in one dollar-denominated asset over another, even though some take a much bigger hit than others, and bonds get creamed during high inflationary times.
The only real way to hedge against this is to put your money in things that are not affected by the value of the dollar, avoiding your assets being significantly devalued by inflation, and calling this phenomenon inflation serves to hide its nastiness. We should instead call it devaluation, monetary devaluation to be specific, and this would at least make its effects a little more transparent and have people stop thinking that this is a fairly benign thing that basically means that things cost more but you make more money and it all ends up being a wash basically.
This is a real threat, not just a minor aftereffect of the shutdown. If seeing the value of your assets decline doesn’t worry you that much, the response to control this certainly will, where we will to some degree need to contract the economy and increase unemployment on purpose again to control this inflation beast, and it is enough of a threat that boosting unemployment and causing a lot of defaults is the lesser evil and must be chosen, because the alternative is even more dangerous.
Jones Understands This Risk, and He is Already Preparing
Jones clearly recognizes this threat, and he’s not waiting around for the economy to get back on its feet to look to protect himself more from this. The normal go-to asset here is gold, and while we mentioned Bitcoin as another asset that can be used for this in our last article on this topic, Bitcoin is considerably more volatile than gold and adds additional risks, where we’re out to reduce risk with this play.
We do think that Bitcoin might be a good hedge against inflation one day, perhaps even during this coming inflationary crisis, if it matures more, and even though it has matured a lot over the past while, it is still too unpredictable and volatile to really contend with gold for this purpose right now.
We might then wonder why Jones is so eager to use it for this purpose, and the answer lies in his also seeing a lot more speculative value in it than gold over the longer term. He wants to use it as both a hedge against inflation and also to speculate with it on the long side, like we do with stocks.
It’s not that gold isn’t expected to have speculative value as well, and since both are stores of value independent of the value of hard currency, they have equal protective value as far as inflationary risk goes. The decision between them comes down to a comparison of their speculative value in fact, how much each may be expected to go up over this time, not only against each other but against stocks as well.
Either Bitcoin or gold therefore cannot just be viewed as hedge plays against inflation, and we also can’t become confused about what we are looking to hedge here either, like some in the media have. Jones is being criticized in the financial media based upon their belief that gold would be a better hedge against stocks then Bitcoin, since they tend to move in the opposite direction more.
That can be true at times, like for instance when we brought up gold’s value as a hedge against the coronavirus pullback back when it started, but told you at the time it was too volatile and that we preferred bonds for this one. That turned out to be the right call, as gold actually followed stocks down over this time, and while it only dropped 12%, the idea here is to have your hedge go up not down.
Treasury funds did go the right way, and provided a great haven for those who were wise enough to know that this was no time to be in stocks and sat this move out and used bonds as a sanctuary. Bonds don’t always align in reverse to stock pullbacks, but had been in a fairly long run up leading into this, and this was the best bet in town and did deliver. Once stocks bottomed, the smart money moved back into them and have been going up ever since.
This is completely different from an inflation hedge, and when inflation runs hot, when business is not only booming but booming to a concerning or even dangerous degree, stock markets not only don’t hate this, they really like it. This does go back to the nominal versus real view though, and if you get a 10% rise in stock prices and 10% inflation, you haven’t made any money at all and this would be the same as investing in gold or Bitcoin and both going nowhere.
If we compare what happened to stocks after the last financial crisis, they basically kept running up from there to this new one, so the aftereffects of going from a recession to having it corrected isn’t a concern. Moving past healthy levels of inflation is a different story, but what puts stocks down in these environments isn’t the inflation, it is the response to it, the slowing down of the economy and the money supply from rate hikes, quantitative tightening, and especially from the defaults.
Depending on the situation, gold and Bitcoin may or may not serve as a good hedge on a nominal basis against all of this ending up producing another big pullback, and that’s not a decision we need to be thinking about this far in advance, and can assess the relative merits of being in other assets, including bonds, when this point arrives. The idea though with an inflationary hedge is to hedge inflation, not nominal pullbacks.
While both gold and Bitcoin are excessively volatile, bonds don’t tend to be and in fact are not volatile enough to be that useful for hedging purposes over cash. This is why it’s worth looking at taking leveraged positions in them, like the 3X leveraged one we’ve been citing when we spoke of hedging with this lately, or even using this as a speculative play that is in its beginning stages of forming,
Bonds are not on the table either to speculate against inflation or even after it gets addressed, because not only do bonds do poorly on the long side in periods of high inflation, the high inflation eats at them as well. Stocks may be going up during these times, where we have to deduct the devaluation of inflation from our returns, but with bonds losing both their nominal value plus how much this is being discounted by inflation, this is no place to be for sure.
When bond yields go up in the presence of higher inflation, this means that the nominal value of bonds decline, and then we have to add the losses to inflation on top of this to calculate our total loss. This approach doesn’t step back from the fire or just watch it, it has us jumping right into it.
Bitcoin is Clearly the Faster Horse, but It Also Bucks Like a Wild Bronco
Jones tips his hand when he tells us that he sees comparisons between Bitcoin now and gold in the 1970’s, and especially when he proclaims that “the best profit maximizing strategy is to ride the fastest horse.” This clearly is much more than an inflation hedge for him, and that part may even be the bonus.
The two are connected though, as the expectation is that people will flee more from hard currency denominated investments and toward both gold and Bitcoin, increasing the demand for both. With Bitcoin easily being the more volatile of the two, and especially given how much higher Bitcoin ran up when the demand for it was so much greater, this is a much faster horse to be sure, although it runs fast against us as well.
Last June, Jones predicted that once gold got over $1400, it will quickly rise to $1700. This wasn’t purely crystal ball stuff, at least the breakout point, and all you needed to do is to look at gold’s chart to see this being a resistance point that it could not get over for the past 5 years.
We broke though $1400 finally the very next month, in July, and we are now over the $1700 mark already. It’s not that it can’t go higher, but Jones at least sees Bitcoin being more bullish over the next while, even though it is up against its own resistance point, not much higher than where we are now as it kisses $10k again.
One of the real advantages of Bitcoin over gold is that we don’t wonder whether Bitcoin is in itself overpriced, and while we shouldn’t be doing that with gold since it is also a pure asset, where its price is determined by the level of demand instead of basing it on fundamental considerations as well as we do with stocks, people will still compare gold’s price to other points in history and wonder whether its price may be too high relative to that.
With nothing in the physical world to compare to, there is no mistaking Bitcoin being a purely artificial thing to bet money on. While it might be limited by its peak of December 2017, it has to double from here to get there, and getting over the $11k hump could indeed open things up more.
There’s also the fact that Bitcoin is about to be halved again, which means that its supply will be slowing down once again. A reduction in supply together with an increase in demand means higher prices every time, serving to skew the move in Bitcoin further in Jones’ direction.
What Bitcoin is most famous for is its very high volatility compared to other assets, even with today’s tamer version. Gold is known to be pretty volatile, but Bitcoin is from another world in this category. While gold did give back 12% for a time when it followed stocks down, Bitcoin gave up half its value during this time for no other reason than people were in the mood to sell, as Bitcoin has nothing to do with the real world.
Bitcoin is the idiot savant of investments, isolated from everything else, capable of great feats, but notoriously hard to predict. Trading it can make you look like a true savant, or make you into an idiot, and it’s not that easy to be on the right side of this.
We liked Bitcoin after it took a 50% haircut during the stock market selloff, just like we liked stocks back then, but given that it has recaptured all of its losses already, and also considering how this asset can go hard the other way so easily, in a way that really isn’t that predictable, entering here would require close watching indeed and we need to be ready to jump if it does stall and rebound.
As for its long-term bullishness, this also involves considerable uncertainty, especially as long as Bitcoin remains in the minors, with stocks, bonds, and gold being in the majors. We’ll know when this changes as this would see a lot more money put into it, and that day may indeed come, especially when inflation starts to rise, although we need to get out of this shutdown and recession first.
Having an investor as renowned as Paul Tudor Jones, with his very big bat, step up to the Bitcoin plate in itself is a good sign that Bitcoin may indeed see his dreams with it achieved, and given how far Bitcoin can take off when you light a fire under it, this fire in itself may propel it forward. It’s Bitcoin though, so this still remains a guess at this point, and we’d like to see it show us what it can do relative to gold once the time comes, which is a way off yet, and also need to see it become more stable to want to hold it for the extended periods that Jones fancies.
You can always trade it for now though, looking to sidestep a lot of the bad stuff and be in for a lot of the good, and that remains our preferred way of playing this right now. If and when it takes off, that will be all the more fodder for our cannons, but it’s hard to imagine just wanting to let this ride unmanaged given its huge swings. Playing Bitcoin has always been a game much more suited to traders, but that may change one day as it matures more.
Jones uses longer-term horizons than we do though, and he very well may end up right about Bitcoin like he was about gold. We applaud his courage with this move though, and we’ll know how right he may be in due time. Bitcoin does look pretty good over the long run though whether it ends up beating gold or not in the battle of inflation hedges that will soon be fought.
Editor, MarketReview.com
Andrew is passionate about anything related to finance, and provides readers with his keen insights into how the numbers add up and what they mean.
Contact Andrew: andrew@marketreview.com
Areas of interest: News & updates from the Consumer Financial Protection Bureau, Trading, Cryptocurrency, Portfolio Management & more.