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Bitcoin — Should Investors and Traders Care?

by D. R. Barton, Jr.

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“The next big thing is the one that makes the last big thing usable.”
                                                      —Blake Ross

In 1992, I had a very serious case of gadget envy. I was a busy, mid-level manager at DuPont who had loads of outside activities. I was finishing up my MBA, playing industrial league basketball and softball, chairing a committee at church, teaching Sunday School and oh yeah, enjoying my life at home with my lovely and talented wife and new baby daughter.  The promise of a gadget that would simplify my hectic lifestyle by keeping electronic track of my calendar and contacts was too much to resist.  I couldn’t wait for the Apple Newton, the first personal digital assistant.  It was set to revolution how we lived.

Well, when the Newton was introduced in 1993, it failed miserably, even famously.  The flop of the Newton was so widely heralded that the Doonesbury comic strip lampooned the devise’s horrible handwriting recognition software for a whole week’s worth of comic strips, the most infamous one being when comic strip character Michael Doonesbury writes “Catching on?” and his Newton deciphers that as “Egg freckles?”

Despite being a commercial and technical fiasco, the Newton left a lasting innovation legacy that is still with us.  Today’s smart phones are just natural extensions of the Newton technology, right down to using the same low energy ARM processor.

As for me?  I read the early reviews of the Newton which praised the concept but railed against the execution and decided to pass.  My patience was rewarded when the first Palm Pilot PDA went public in 1996.  The Palm was a device that did three things, and did them well — calendar, contacts and to do lists were excellently managed, and this time, Palm’s Graffiti handwriting recognition software really did deliver.  The Palm was a success, the next logical step after the Newton’s demise.  And the Palm also led to what was arguably the first great smart phone, the Treo, which dominated the smart phone market right up until the introduction of the Newton 2 — umm, I mean the iPhone.

So the question before us is this — will Bitcoin follow in the Newton’s footsteps as a brilliant innovation that ultimately fails yet leaves behind a technical and conceptual legacy from which others can build? Or, will it be more like the Microsoft PC operating systems that dominated the early commercial adoption of the PC and continue to utterly dominate the market today with more than a 90% market share?

It’s an intriguing question, and one that generates very passionate answers from both sides.  With last week’s background information in place, let’s dig into the Bitcoin world a bit deeper and look at who else might emerge as big winners in the virtual currency game.

Some Reasons Why Bitcoin Might Survive (or Even Thrive)

Similar to the Newton PDA adoption, the devil of virtual currency will certainly be in the details.  As we’ll see with almost all of the issues that will drive the acceptance of Bitcoin one way or the other — there are two sides to each story!

In this section we’ll look at a few of the key factors that favor continued growth in Bitcoin acceptance.  Here, I’m concentrating on current Bitcoin issues though some are generic.

• Bitcoin’s internal security seems to have stood the test of a large number of transactions.  Other than a flaw that was corrected in 2010 (that allowed bitcoins to be generated outside the standard protocol), there have been no major security flaws in the system.  All of the recent problems have been with the ancillary elements of the ecosystem (notably wallets and exchanges) — more on that in the next section.  This issue of security is really the key in establishing trust between two unknown parties that want to transact.

• Low transaction costs: which seems to be true, especially if the system continues to grow in both size and value and bitcoins are still being produced by the system.  The issue of what happens as the system approaches its cap of 21 million bitcoins is a little more unclear…

• These low transaction costs allow the possibility for many interesting things to happen like helping the working poor around the world who don’t have bank accounts.  This social justice aspect of Bitcoin could help to win needed regulatory support (or win the lack of regulatory interference, depending on your vantage point).  However, most on-the-ground efforts to reach those who need help are extremely modest; it’s not difficult to imagine that those without bank accounts are also not very tech savvy.  For example, Bloomberg Businessweek reports that 50 – 65% of electronic transfers made in the poorest countries like Bangladesh, Pakistan and Kenya are conducted like this:  the person with cash goes to a person/agent with a digital account to transfer money to another person/agent with an account who finally swaps the transfer back into cash and gets it to the fourth person — the intended recipient.  Unless the middle parties are friends or relatives, transaction fees must be paid.  So for now, it would seem this social justice aspect is more attractive in theory than in practice.

• Bitcoin as a technology base for a broader network of products and services. Because Bitcoin has first mover advantage (at least first large-scale mover), many incubator businesses are building on its foundational technology (some with very serious backing).  The value of this network has been described as a positive feedback loop — the more people who use it, the more valuable it becomes to all users, etc.

• Some very smart venture capital players are investing in Bitcoin-based companies.  Marc Andreessen of Netscape fame who has also backed some really big start-ups (like Facebook, Twitter and others) and Fred Wilson are putting their firms’ money behind the technology.

• Lastly, despite the major recent problems with bitcoin exchanges (most notably Mt. Gox), the price of bitcoins has remained relatively robust.  Bitcoin’s largest exchange shutdown is a story of mismanagement, weak accounting practices and poor security.  To have price remain as strong as it has means that lots of people are still putting their trust in the currency.  Here’s a chart that shows the run-up in bitcoin price late last year, the correction in December based on the Chinese central bank announcement, as well as the day that Mt. Gox shut down and the subsequent recovery:

The Issues That Just Might Make Bitcoin the Next Newton

While there are some smart people betting that Bitcoin will grow, there are some equally smart folks who think it’s heading to zero (see last week’s Warren Buffet quotes). If it does, it will be because this most democratic of currencies has lost the trust of users.  Here are some of the top reasons that could happen:

• The exchanges are still a joke.  Mt. Gox started out as a trading card site, for Pete’s sake.  Until there is a credible, trusted place to turn your bitcoins into dollars, euros, yuan, whatever — bitcoin will be limited.  It will be interesting to see if some serious institution steps up to take on this challenge.

• Digital wallets are the other weak link — though to be fair, they are generally much more secure than the online banking protocols that most people use. Malware, that targets Bitcoin wallets, has grown in number and sophistication since the Bitcoin market capitalization has exploded.  Until someone comes up with an extremely secure yet simple-to-use wallet, regular consumers will not come into the fold en masse.  And for all the Bitcoin fan boys and girls out there, having a second dedicated computer that never goes online as a place to store addresses or keys is not a “simple to use” solution for most people…

• Regulatory permission — Fed Chair Janet Yellen said in congressional testimony that, “…the Fed doesn’t have authority to supervise or regulate Bitcoin in anyway.”  Deposits in U.S. banks (and most other countries) have federally regulated deposit insurance.  The same for most brokerage accounts.  Will mainstream buyers put significant assets into Bitcoin without similar protections?

• Law enforcement & tax collection issues.  We touched on these issues briefly last week.  Both are still gray areas — especially the law enforcement side. Many Bitcoin transactions can be traced, but for someone who uses software built to hide identities within the internet (e.g. Tor), the opportunity for anonymity still easily exists.  On the tax front, a Wall Street Journal article in December reports that there is still no official word on taxation for virtual currency ownership or transactions. An agency spokesman released the following statement: "The IRS continues to study virtual currencies and intends to provide some guidance on the tax consequences" of transactions involving them.  As for tax avoidance or even evasion, rulings on the use of bitcoin are even murkier.  I expect some less-than-favorable Bitcoin rulings coming from the U.S. and other countries’ revenue collectors.

Bitcoin and Its Relationship to Investing and Trading

I don’t believe that Bitcoin can take its next step up in trust and acceptance without some broad-based governmental support.  Absent that, if all other pieces work, it can only make incremental growth steps as an alternative currency. 

But with a governmental vote of confidence (or at least non-objection) and a strong exchange player or three, Bitcoin could put a stranglehold on the virtual currency market.

Next time, we’ll look into the companies that are most likely to benefit from the inevitable virtual currency growth curve, as well as those likely to suffer.

I’d love to hear your thoughts and feedback — just send an email to drbarton “at” vantharp.com.  Until next time…

Great Trading,
D. R.

About the Author: A passion for the systematic approach to the markets and lifelong love of teaching and learning have propelled D.R. Barton, Jr. to the top of the investment and trading arena. He is a regularly featured guest on both Report on Business TV, and WTOP News Radio in Washington, D.C., and has been a guest on Bloomberg Radio. His articles have appeared on SmartMoney.com and Financial Advisor magazine. You may contact D.R. at "drbarton" at "vantharp.com".

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Trading Tip

Gold and Silver Update: March 19, 2014

by Florian Grummes

Arguments for lower prices:

• Overall Gold still is in a downtrend. US$1,525.00 remains the line in the sand. Gold will need much more time to break through this heavy resistance. Only a move above US$1,430.00 will indicate that the mid- and longer-term trend indeed has changed.
• Gold Monthly Chart: MACD sell signal active since November 2011 (this is extremely powerful and needs to change before one can call the bottom). Due to Gold´s recent strong performance it looks like MACD could create a buy signal within the next 1-2 months.
• Gold Daily Chart: Gold started into the new week with the highest high of this rally but took out Friday´s low later in the session. This is called a key reversal and is bearish. RSI turning down from overbought levels, MACD is about to create a sell signal and embedded Stochastic has been lost.
• Gold CoT-Data: Last week the commercial net-short position increased to 125,367 contracts.
• Gold/Silver Ratio: The ratio closed at 65.14 yesterday. Silver is lagging and does not confirm Gold´s recent bull run.
• Junior Gold Miners (GDXJ): Already down 9.5% since last Friday. Looks like a correction in the mining sector is finally starting. But Golden Cross of 50-MA & 200-MA is about to happen soon and will support the GDXJ around 39 points.
• Seasonality: During march the seasonal window typically is negative for Gold and Silver. April instead tends to be a good month for precious metals. But the best buying opportunity normally shows up at the summer lows somewhere in June/July.
• Demand: On Monday the Indian Government again increased the import tariff value for Gold to reduce the high current account deficit. With the latest increase the supply crunch in the domestic Indian market will likely continue. India´s official Gold imports are expected to fall by 34% in 2014.
• Sentiment: Latest Kitco weekly Gold Survey showed 84% bulls. Another week above 80% and we have a strong contrarian sell signal. As well Sentiment Score from sentiment trader.com is at 75%. This is the highest level in the last 2.5 years.
• U.S. Dollar-Sentiment: According to sentimenttrader.com public opinion for the U.S. Dollar is at levels from where typically a rally started in the past four years. Of course within a bear market the sentiment can and will typically reach extreme levels of pessimism. But combined with a positive seasonality until summer the U.S. Dollar might start a surprising recovery.
• Economic Calendar: This week´s FED policy meeting might have a short-term negative influence on Gold. Typically Gold is down when the public focus is on the FED. Simply put, when central bankers speak a rising Gold price is not good for the image.

Arguments for higher prices:

• Since end of December Gold has been rising without looking back. With a US$25.00 trailing stop you could have caught most of the rally. Despite the setback since Monday morning the chart is still bullish. The critical support level around US$1,180.00 is far away. Now we have to see how far this correction goes.
• Gold Weekly Chart: Gold moved higher during the last 6 weeks. All indicators are still positive. Stochastic is embedded. RSI still has plenty of room to move higher.
• Gold Daily Chart: Gold is above it´s 200-MA (US$1,302.23) and above it´s rising 50-MA (US$1,292.83). Pretty soon we should see a gold cross of these two moving averages which will create a strong mid- & long-term buy signal.
• US-Dollar: Normally US-Dollar should have experienced some sort of safe haven buying during the last couple of weeks. Therefore something must be wrong with the US-Dollar (e.g. anemic business and economic activity in the U.S.). A weak U.S. Dollar will support Gold.
• Geopolitical tensions due to Crimea conflict continue to raise and could lead to a disaster  This crisis has the potential for the 3rd world-war. Let´s hope that the political leaders will calm down and find a diplomatic solution. Unfortunately this is not very likely.
• Russian millionaires have lost about 10% in their currency since beginning of 2014. On top European Union imposing sanctions on wealthy Russian individuals. These people might flee into Gold to protect their wealth.
• The bursting of China´s credit bubble is coming closer. On Monday a bigger Chinese real estate company got bankrupt. If China´s rich people only move 5% of their assets into Gold the physical market will explode.

Conclusion:

• Last time I argued that if Gold should close above US$1,350.00 the rally would continue. And indeed driven by the Crimea crisis Gold moved up to US$1,392.00 but missed my target at US$1,430.00. Since Monday morning Gold is down more than US$45.00 and the P&F-Chart signals an end of the bull run for now. The geopolitical stress in the Crimea had been priced in completely and the market sold the news on Monday. Seems to be illogic but that´s how markets work.
• The important question now is: How far does this correction go and how long will it take? 
  • One could use the simple Fibonacchi retracements to get an indication: 38.2% = US$1,311.40, 50% = US$1,286.32 and 61.8% = US$1,261.23.
  • Very likely is a test of the flattening 200-MA (US$1,302.23) and/or the rising 50-MA (US$1,292.83) in the coming days and weeks.
  • Overall the picture remains bullish and already US$1,345.00 offers short-term support that could either hold or give away after today´s FOMC meeting.
  • The uptrend-line comes in around US$1,330.00 and should offer solid support during the first test.
  • The rising lower daily Bollinger Band (US$1,308.52) is good support too.
• Therefore my worst case scenario would be a sell-off down to January´s resistance around US$1.270,00.
• Personally I think the 200-MA will hold at least for the next two weeks and will be good for a bounce. With the golden cross soon in place Gold might start a new rally without dipping below US$1,300.00.
• Short-term Traders could place a buying order around US$1,330.00 and scale out into a recovery towards US$1,345.00/ US$1,355.00/ US$1,365.00. Or they could be more patient and wait for the first test of the 200-MA to initiate a position. Right now I don´t see a good short entry anymore. Only a recovery towards US$1,382.00/US$1,430.00 combined with negative divergences would get me to short the Gold-market.
• Investors with a long-term perspective should concentrate on silver for now. A couple of weeks a go Silver exploded higher, but I told you to wait and be patient. Now it´s the time to buy silver below US$20.80. Regarding Gold I´d be a physical buyer below US$1,3150.00, below US$1,290.00 and below US$1,270.00.

Longterm:

• Nothing has changed
• Precious Metals bull market continues and is moving step by step closer to the final parabolic phase (could start in summer 2014 & last for 2-3 years or maybe later)
• Price target Dow Jones/Gold Ratio ca. 1:1
• Price target Gold/Silver Ratio ca. 10:1
• Fundamentally, Gold should soon start the final 3rd phase of this long term bull market. 1st stage saw the miners closing their hedge books  2nd stage continuously presented us news about institutions and central banks buying or repatriating gold. The evolving 3rd and finally parabolic stage will end in the distribution to small inexperienced new investors who will be subject to blind greed and frenzied panic.

Click here to see Florian's report in it's original format.

About the Author: Florian Grummes (born 1975 in Munich) has been studying and trading the gold market since 2003. In addition to his trading business, he is a very creative and successful composer, songwriter and music producer.

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