What do hedge funds and celebrities have in common?

For some of each, a clear case of stupidity

The collapse of FTX exposed the stupidity of a number of Hollywood elites and high-flying “hedge” funds. Larry David, Tom Brady and his ex-wife, and hedge funds Tiger Global, Sequoia Capital and Third Point join the Ontario Teachers’ Pension Plan as investors who lost millions on the FTX scam. Like millions of others, these supposedly “sophisticated” investors bought into the cryptocurrency fad that has cost investors over $2 trillion in the past few years.

Starting with Bitcoin, some 19,000 “coins” have been created and sold to eager crypto fans through “exchanges” based on the narrative that cryptocurrencies have value, are safer than fiat currencies (which are backed by the full faith and credit of issuing governments) and are a “hedge against inflation”. We have global inflation but the claimed “hedge” is exacerbating the losses rather than providing any “hedge”.

You would think the existence of 19,000 different cryptocurrency “coins” would have been a clue that pretty well anyone can create a “crypto” coin. Any business where the barriers to entry are this low suffers from a proliferation of alternatives. These “coins” (they are a long way from actual coins) produce nothing, create no cash flow, and exist soley on the basis that anyone who holds one believes they can find a greater fool to sell it to and pass the buck. They added nothing to payment systems, their pretense of anonymity totally lost in the reality that the “blockchain” provides a verifiable trail as to who held each “coin” and when. Actually providing money to an “exchange” to acquire a cryptocoin is about as safe as your local convenience store cash register. Getting a fiat currency out of an exchange is an equally insecure transaction. There is no “security” in the cryptocurrency space.

Some claimed Bitcoin and its ilk were an alternative to gold as an inflation hedge, a conclusion bolstered by the rapid run up in Bitcoin in its early years and the sluggish change in gold prices during a long period of low inflation and low interest rates. The claim has as much validity as the claim that tulips were a hedge against inflation in the early 1600’s when tulip prices ran as high as a year’s salary for a single bulb. There is simply no cure for stupidity.

Now the bloom is off the rose. Inflation began in earnest in 2020 as the world began to emerge from the pandemic. By July 2022, U.S. inflation had soared from near zero in 2020 to 9.1%. How effective was the Bitcoin hedge? In 2020, Bitcoin lost half its trading value in a two day plunge.

The Bitcoin narrative is similar to the “climate change” narrative. It is a saleable story devoid of substance that captures the imagination of the gullible and leads to calamitous outcomes. The losses on cryptcurrencies are now in the trillions and money squandered on the “fight against climate change” now amounts to trillions. Common sense is no longer common.

Bitcoin and its peers are classical Ponzi schemes. They create no value, are backed by no assets or taxation capability, and depend on new investors buying the “coins” to turn them into currency that can be readily exchange for real assets.

Climate change is a political narrative aimed at redistributing wealth from rich countries to poorer ones and to investors in “renewables” from ordinary taxpayers.

Neither will have a happy ending.

But there is opportunity for the informed. Gold remains a “hedge” against inflation, inflation is here and likely to remain for a while, and companies like Agnico Eagle (AEM.TO), Barrick Gold (ABX.TO) and Marathon Gold (MOZ.TO) offer investors value -real value, not smoke. No one should think they are “sure things” since commodity prices are volatile, recession is likely and all ships rise and fall in the same tides. But until governments take actions to fill the growing shortage of fossil fuels which underlies the inflationary trend, inflation will persist (and no doubt ebb and flow with interest rates and the level of economic activity) and gold stocks offer some protection.

I particularly like Agnico Eagle. While the stock is expensive (EV/EBITDA of about 16 times at today’s gold price) its profitable, has a pristine balance sheet and pays a dividend of about 3%. With annual gold production of over 2 million ounces at an all in sustaining cost of about $1,126 an ounce, the company high high leverage to gold prices. Headwinds are rising interest rates which traditionally have put a lid on gold prices and rising mining costs in an inflationary environment. Most sell-side analysts thinkt the stock is undervalued. I don’t. I think it represents reasonable value and makes a contribution to a balanced portfolio by providing a hedge against runaway inflation. Inflation is not at the “runaway” stage in North America but there are a dozen countries with very high inflation rates, and there is no reason to pretend it cannot happen here. If we see oil prices run to the US$110 level projected by Goldman Sachs, inflation will accelerate again.