Key Points:
- The correlation between cryptocurrencies and traditional asset classes has been changing.
- Interest in digital assets remains high, with a significant portion of Americans having invested in or used cryptocurrencies.
- Bitcoin, once seen as a hedge against equity markets, now shows a growing correlation with the S&P 500.
- To assess the relationship between cryptocurrencies and traditional asset classes, data on five cryptocurrencies and various funds and commodities were analyzed.
- The correlation between cryptocurrencies and sector ETFs is relatively low.
- Growth funds exhibit a stronger correlation with cryptocurrencies than value funds.
- The correlation between cryptocurrencies and bonds is even weaker than with equities.
- Cryptocurrencies have little to no correlation with commodities.
- Investors need to be discerning about which cryptocurrencies they choose to invest in.
- Crypto’s weak correlation with traditional assets may offer diversification benefits for long-term investors.
The recent bankruptcy of the FTX exchange has sparked a renewed interest in understanding the evolving relationship between cryptocurrencies and traditional asset classes. Despite the current market dynamics, the popularity of digital assets remains high, with a significant percentage of Americans having invested in or used cryptocurrencies.
Bitcoin, once hailed as a hedge against equity markets and a potential addition to investment portfolios, now shows a growing correlation with the S&P 500. This indicates that cryptocurrencies are moving increasingly in tandem with equities, rather than providing a diversification benefit.
To further understand the relationship between cryptocurrencies and other asset classes, an analysis was conducted using daily price data for five cryptocurrencies (Bitcoin, Ether, Litecoin, XRP, and Cardano), various mutual funds, sector ETFs, and commodities. The goal was to determine whether cryptocurrencies are uncorrelated or negatively correlated with traditional assets, which would suggest a diversification benefit, or if a crypto allocation could be counterproductive.
The analysis revealed that the correlation between cryptocurrencies and sector ETFs is relatively low. The correlations range from 0.1 to a maximum of 0.39, with XRP showing the lowest correlation. Among the sector ETFs, the highest correlation with cryptocurrencies was observed in the US technology and US materials sectors, although the correlation was still weak.
When analyzing the correlation between cryptocurrencies and mutual funds, the results showed a relatively weak but slightly stronger relationship compared to sector ETFs. Growth funds exhibited a stronger correlation with cryptocurrencies compared to value funds. This implies that crypto assets are weakly sensitive to the interest rate dynamics that have driven recent drawdowns in growth stocks.
The correlation between cryptocurrencies and bonds was found to be even weaker than with equities. This indicates that cryptocurrencies have little to no correlation with the bond market.
When it comes to commodities, the analysis showed that cryptocurrencies have negligible positive or negative correlations with them. Only natural gas showed a low negative relationship with certain cryptocurrencies. The correlation between cryptocurrencies and the precious metal silver was the highest, but still relatively weak.
In conclusion, cryptocurrencies have a low positive correlation with mutual funds and sector ETFs, indicating an increase in cross-market trading and the growing popularity of cryptocurrencies. In a rising interest rate environment and amidst the diminished efficacy of the traditional 60/40 equity/bond portfolio, cryptocurrencies’ weak correlation with traditional assets may offer potential diversification benefits for long-term investors who can withstand added short-term volatility. However, it is important for investors to be discerning about which cryptocurrencies they choose to invest in, as not all cryptocurrencies display the same lack of correlation with traditional assets.
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