Bitcoin vs Real Estate

Unless you just arrived on earth, you’ve probably heard about Bitcoin mania.

In case you haven’t, here’s a 7-year chart which clearly illustrates what all the excitement is about …

Source: CoinDesk.com

In case that pattern looks familiar … here’s what the NASDAQ looked in the late 90’s during the dotcom mania (the big spike in the middle) …

Source: BigCharts.com

And to be fair, here’s housing … note the run up from ’99 to ’07 ….

Source: Calculated Risk Blog

The only difference between Bitcoin and the Nasdaq or housing charts is we know the rest of the story for tech stocks and housing.

Is Bitcoin going to crash like tech stocks and housing did?

Not necessarily … though we wouldn’t be surprised.

But we do think there are some lessons and opportunities in taking a closer look at what’s going on with Bitcoin.

Price Action

The price of anything is almost always the direct result of supply and demand with capacity-to-pay (you can want something, but if you can’t pay, you can’t bid).

When demand exceeds supply, prices are likely to get bid UP.  And if you add capacity-to-pay to a demand that’s over-whelming supply, prices can go hyperbolic.

Bubbles

Bubbles form when enthusiasm for a particular “asset” causes bidders to cross over from buying “fundamentals” to buying “momentum.”

When we say “fundamentals” we mean income and not supply vs demand.

With stocks, “fundamentals” are earnings per share.  The ratio between price and earnings is cleverly called the price-to-earnings ratio (P/E).

When a stock gets “hot”, investors are willing to pay a lot more for the same earnings.  Here are examples where the relationship between price and earnings are all over the place …

Apple recently announced their earnings at $2.07 per share.  Apple’s stock price is about $175 per share.

Exxon reported earnings of 93 cents per share at a price of about $84.

Amazon reported earnings of 52 cents a share at $1045 per share.

Google had earnings of $9.57 per share at $1022 per share.

If you’re buying fundamentals, it seems Apple and Exxon are better deals than Amazon or Google. You pay less for the income.

But the price action says the market is more excited about the future of Amazon and Google.  Clearly, bidders are buying something more than income.

Of course, we’re not stock investors or analysts, so we’re not recommending anything.

The point is when investors see future growth, they’ll often bid the price UP in an attempt to “buy low” … presumably hoping to “sell high” later.

But sometimes investors get TOO excited and they buy something simply because “it’s going up” … and they want to get in on the action.

Forget fundamentals.  The only things that matters is everyone else is piling in and pushing the price up.

That’s what happened with tech stocks in the late 90s.

Investors bought the idea of a “new” economy … one where “old-fashioned” concepts like revenue and profit fell by the wayside.

Back then companies were going public … with little or no profit … and eager investors would bid the prices up to double and triple digit increases in just a matter of hours.

It made no sense.  But it happened.  Many people became multi-millionaires by getting in early.  Some stayed multi-millionaires by getting out early too.

Bubbles occur when more people are coming in than getting out.  Bubbles deflate when that reverses.

When there are no fundamentals, it’s all about getting the timing right.

Real Estate

The real estate bubble was similar … but different.

In the dotcom mania, most people were investing cash, though some used debt (margin).

With real estate in the early 2000’s, the price boom was fueled almost exclusively by debt … specifically, mortgage-backed-securities (MBS).

Debt allows people to pull future earnings into the present to bid up price today.  Cheap mortgages let people lever their paychecks into big loans.

In the beginning, people who had legitimate income and reasonable down payments were the buyers.  Lenders underwrote for income (fundamentals).

But after the dotcom bust, the Fed pumped lots of money into the financial system and Wall Street needed someplace to put it.

Stocks had a big black eye, so the money ended up in bonds, which drove down interest rates (when bonds go UP, yields … rates … go DOWN).

As bond yields fell, bond investors went looking for yield.  So Wall Street served up mortgages as a “safe” place to invest for better yield.

As more money poured into real estate, real estate prices rose further.  Real estate got “hot.”

Wall Street investors fed mortgages backed by real estate “going up” … without regard to the income of the borrower.

Soon, fueled by cheap money from Wall Street, Main Street was buying real estate without regard to their own income or the rental income.  All that mattered was prices were going up.

It was all good … until it wasn’t.

When the fundamentals (income and rents) couldn’t support the debt load and loans inevitably began to default (starting with sub-prime), no one wanted to buy mortgage-backed securities anymore.

So all the money going into MBS and fueling real estate stopped.

When it did, buyers lost the capacity-to-pay, and the supply and demand imbalance flipped in favor of supply.  Prices crashed.

Bitcoin

We’re the first to admit we’ve missed out on the Bitcoin “boom” so far.

When we first heard of Bitcoin, it didn’t make sense to us because it was being presented as a currency … a medium of exchange.  A way to buy and sell things.

Of course, today almost no one is using Bitcoin as a currency … any more than people still use gold as a currency. And Bitcoin, like gold, has no earnings.

Just as we don’t consider gold an investment, but rather a place to store wealth outside the dollar, we don’t think of Bitcoin as an investment either.

What we didn’t see was the potential for a huge supply and demand imbalance to cause Bitcoin prices to go hyperbolic.

It’s well known the supply of Bitcoin is allegedly limited to only 21 million Bitcoins.  We have no idea how anyone could verify this … but we’re admittedly ignorant.

However, there seems to be no limit to the number of other crypto-currencies which can be created.  Time will tell whether the supply of cryptos will catch up to or exceed demand.

But looking at the Bitcoin chart above, it seems apparent something happened in the last few months to create a HUGE demand.  To our knowledge, nothing happened to supply.

Based on the news and all the geo-political unrest, one potential demand driver could be wealthy people trying to get big money out of totalitarian regimes.

ChinaVenezuela and Saudi Arabia come to mind.

Such a surge of demand with capacity-to-pay could cause a big spike in prices.

Then, when everyone else sees Bitcoin going up … for WHATEVER reason … they all get in to ride (chase) the wave.

Because there’s no way (that we know of) besides the price action to really know what the Bitcoin supply and demand numbers are, it seems dangerous to go all in with real money.

Remember, just because it’s going up doesn’t make it safe.

If the momentum turns, now you’re in a race with everyone else to get out.  And that almost always ends badly.

However, if you have some throw away money and you want to take chance on a moonshot … we’ve certainly blown money on less interesting things.

We first heard about Bitcoin in 2010 and could have easily put $100 in just for the fun of it.  It would be worth over $200 million at today’s price.  Instead, we bought sushi.  Oops.

Real Estate vs Bitcoin

You’ve probably already figured out … there’s no comparison.

Bitcoin and real estate are two very different financial vehicles and they play different roles in your portfolio.

Bitcoin is about betting on price action … getting in while demand is growing in the face of limited supply.  Then being fast enough to get out before it turns.

Real estate is about buying streams of income by using debt to acquire a tangible asset with thousands of years of history of being in demand.  Humans will always need places to live, work, farm, and play.

Of course, if we use some “throw-away” money to buy Bitcoin and it goes up 10,000%, we wouldn’t complain.  We’d probably just cash out and buy some gold and real estate.

One thing’s for sure … the future of money and wealth are changing … and there will be unprecedented risks and opportunities as everything unfolds.

Until next time … good investing!


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