The
first surprising hedge fund play of 2014 has emerged not in an established
stock or commodity, but in the emerging digital payment platform known as
Bitcoin. While purists insist it is
neither a currency nor a commodity, there’s no denying the growing popularity
of Bitcoin. The digital unit of stored
value is attracting more and more interest from a wide array of individuals
seeking an alternative to fiat currencies.
Now it seems that even major financial institutions are set to enter the
fray.
As
with any speculative medium, it was only a matter of time before hedge funds
jumped on board the Bitcoin phenomenon.
According to a Bloomberg report, a San Francisco-based hedge fund is
looking for a junior Bitcoin trader. As
one reporter put it, “Where big money is, hedge funds go as well.”
The
Bitcoin protocol will undoubtedly attract more interest from hedge funds, which
in turn will push its value higher. As
an analyst interviewed by Bloomberg pointed out, “Huge price fluctuations is exactly
what [hedge funds] are looking for.
[They] love nothing more than mad volatility, and that’s exactly what
you’ve seen in Bitcoin.” And as we’ve
seen in all too many cases, when hedge funds commit their capital to anything
that’s already in an established uptrend, it can only succeed in generating
additional upside momentum.
Analysts
have noted the lack of liquidity in the Bitcoin market and have suggested this
as a reason why a bubble may not grow to gargantuan proportions. Conventional trades in Bitcoin aren’t
possible at this time due to the extremely slow transactions times, but that
will likely soon change with Wall Street’s increasing presence in the market. Hedge fund managers are momentum specialists
who not only thrive on upward trending markets, but who can collectively create
a manifold increase in momentum in the markets they focus on.
Consider
for instance the presence of hedge funds in certain individual China
stocks. You’ll recall the bubble in
U.S.-listed China stocks from a few years ago.
While many of these stocks have since deflated, there are still to be
found a few conspicuous examples of the active influence of hedge fund
managers. At the time the hedge funds
took speculative positions in certain low-priced China shares, these stocks
were highly illiquid. Sometimes two or
three days would go by without a single transaction being made in them. Yet this didn’t deter the “hedgies” from
taking a large stake in them.
Two
examples that come to mind are Ping An Insurance Group Co. (PNGAY) and the U.S.
listed version of Agricultural Bank of China (ACGBY), both of which are known
to be heavily owned by hedge funds. To
this day, despite China stocks being in a bear market, PNGAY has not only seen
increased liquidity due to hedge fund presence, but the stock recently
experienced a run-up that can only be attributed to hedge fund-created
momentum. Note the follow chart which
shows PNGAY’s price trend in relation to the sagging Shanghai Composite Index,
the main benchmark for Chinese stocks. After
experiencing a “blow off” top in November-December, PNGAY has since
sagged. Yet the heavy trading volume and
upside momentum of recent months is testament to the power of hedge fund
speculative activity in a historically illiquid market.
From
the above example we can learn an unmistakable lesson, namely that hedge fund
presence in Bitcoin is a double-edge sword.
While it will only serve to attract more attention toward the emerging
virtual currency and eventually increase its liquidity, it will also create
ever-increasing price gyrations. This
will defeat the goal of Bitcoin’s stability vis-à-vis the dollar that many of
its exponents had hoped for. In short, the
early appearance of hedge funds in the Bitcoin market virtually assures the
expansion of a massive bubble – and its eventual implosion.
