Grayscale Bitcoin Trust And The Attack Of The Fed (OTC:GBTC)

Grayscale Bitcoin Trust (OTC:GBTC) has been taking a beating over the last year, plunging from a 52-week high of $55.05 to an all-time low of $11.03. That has been the direct result of the price of Bitcoin (BTC-USD) plummeting from its all-time high of $68,770, to approximately $19,000 as I write.

The major reasons for the decline in the price of Bitcoin is the Federal Reserve raising interest rates to combat high inflation, the flagship crypto moving in correlation with high-risk assets, and the strength of the U.S. dollar.

In this article we’ll look at why I believe Bitcoin and GBTC have more limited downside than some bears think, and what the factors are to look for in order to get a clearer understanding of what the near-term probabilities are for GBTC.

Grayscale Bitcoin Trust and its recent performance

While I’ve already mentioned the share price movement of GBTC in my opening comments, another factor to consider with the performance of GBTC has been that it has been recently trading at a discount in the 33 percent to 35 percent range to its net asset value (“NAV”); that’s important to take into account because for some time it had traded at a high premium to spot prices of Bitcoin. That started to change when the first Bitcoin ETF was launched in Canada in February 2021.

Those taking a position in GBTC don’t have direct ownership in Bitcoin. GBTC buys and holds Bitcoin, essentially acting like a Bitcoin tracking mechanism for investors.

GBTC holds over 640,000 Bitcoin, accounting for 3.12 percent of all Bitcoin in the world at this time. It has an annual management fee of 2 percent.

Since institutional investors have favored the Trust because they can manage their positions via a brokerage account, one reason for the precipitous decline in the share price of GBTC has been institutional investors fleeing the Trust for safer holdings.

Take into consideration that institutional investors view Bitcoin and GBTC in the same way they view high-growth tech stocks, i.e., they position-size based upon how rising interest rates will impact future cash flows and profits.

Attack of the Fed

Federal Reserve Chair Jerome Powell has stated clearly that his goal is to crush inflation. To do that he has to continue to boost interest rates until inflation sustainably declines.

Powell has communicated that he has a goal of increasing interest rates to 4.6 percent. If he can get away with that in relationship to inflation, I have no doubt that he’ll stop there. Even so, there is no certainty that it’ll be enough to curb inflation’s momentum, so it wouldn’t surprise me to see interest rates rise to 5 percent, or possibly a little higher.

If it plays out that way, it will definitely trigger another sell-off, pushing down high-risk assets, including GBTC.

On the other hand, those calling for the Fed to be far more aggressive in its interest rate strategy have been invoking Paul Volcker, who as head of the Fed 1979 to 1987 boosted interest rates to a high of 20 percent. The problem there the current conditions are far different from that time, especially as it relates to how much debt the U.S. government currently carries.

If the Fed were to raise interest rates much beyond 5 percent, it would put heavy pressure on the U.S. government because the amount to pay off higher interest rates would be cost prohibitive; it could possibly bankrupt the country. We know Powell isn’t going to take that type of action.

This is important to take into account because it limits the ceiling on interest rates while lowering the floor on responses by the market to high-risk investments. That provides visible parameters for investors when looking at entry points for GBTC.

How to determine the parameters

The major factor to consider when looking at how the market is going to respond to the Fed, is the above-mentioned interest rate hike stated by Jerome Powell. The goal of increasing interest rates to 4.6 percent should be the benchmark to work from, with the added idea it could go as high as 5 percent, or a little above that.

With that in mind, the next three CPI readings will determine what actions, and to what degree, the Powell and the Federal Reserve will take. If the next report shows inflation slowing down, I think we’ll an increase of 50 basis points, as the market is already pricing in. If inflation drops in any significant way, it’ll trigger a temporary boost in stocks, with the result being an increase in the market floor.

In my opinion that won’t be enough to get investors too excited, as they’ll definitely wait for the subsequent CPI numbers to confirm things are starting to turn around. Once that happens, we’ll start to see more money flowing into high-growth assets. It won’t be a flood, but it’ll signal a change in sentiment to one of more bullishness.

Finally, near the end of 2022 and early 2023, if inflation is shown to slow down for three months in a row, it’s likely Powell will stop raising interest rates and the money will start flowing once again to high-growth companies and Trusts like GBTC.

At that time the U.S. dollar will have weakened as well, providing favorable conditions for investors looking to confirm the bottom is in fact in.

Conclusion

As the Federal Reserve goes (under current economic conditions), so goes Bitcoin, and as Bitcoin goes, so goes GBTC. That correlation will remain in place at least until confirmation comes that inflation is sustainably dropping. Again, I believe that’s going to happen in the latter part of 2022 or early 2023.

The market will be watching inflation, interest rates, and the strength of the U.S. dollar to determine when to feel more comfortable in taking on more risk. Another thing to consider is investors don’t want to miss out on the upcoming rebound once it comes; the combination of FOMO and caution are pulling against one another now. Once there is more clarity, investors will psychologically move toward FOMO, which will bring about more investment in high-growth companies and/or Trusts like GBTC, resulting in its share price returning to growth mode.

A key to visibility, to me, is understanding the Fed is limited as to how high it can raise interest rates because of the record debt held by the government. For that reason, GBTC offers a good entry point as it stands today, and even if there is one last plunge in its price, patient investors will reap some solid returns in the months and years ahead.

And for those that like GBTC but are still concerned, simply use a dollar-cost averaging strategy to take advantage of this compelling opportunity to take a position in GBTC at a price we’re not likely to see for years, if ever again.