Gold and Bitcoin both hit historic highs, U.S. government shutdown stimulates "dollar depreciation trade"

As concerns grow among investors about the U.S. fiscal outlook and the value of the dollar, a "devaluation trade" aimed at hedging against dollar depreciation is becoming one of the most popular investment themes this year, driving both gold and Bitcoin prices to historic highs.

The partial shutdown of the U.S. federal government that began last Wednesday further fueled this trade. On Monday, the 6th, spot gold broke through the $3,900 per ounce mark, rising 0.35% on the day, setting a new historical high. This comes less than 10 days after it first surpassed the $3,800 mark. Meanwhile, Bitcoin reached a high of $125,689 on the 5th, surpassing the previous record of $124,514 set on August 14.

The ICE Dollar Index (DXY), which measures the dollar against six major currencies, fell 0.1% on Friday, with a cumulative decline of about 10% this year. Investors are accelerating their shift away from fiat currencies like the dollar towards alternative assets seen as stores of value.

This "devaluation trade" strategy has gained favor among retail investors on the eve of the 2024 U.S. presidential election. Analysts believe that regardless of whether this government shutdown is brief or lasts for weeks, the structural factors behind it suggest that this trade still has room for further growth in the future.

The Logic Behind the Dollar "Devaluation Trade"

The core of the "devaluation trade" is broadly diversifying investments from fiat currencies like the dollar to other assets. The momentum for this trade comes from several long-term factors, including uncertainty about long-term inflation and the trajectory of U.S. fiscal policy, concerns about the independence of the Federal Reserve, and the outlook of persistently high deficits in major economies.

Matt Stucky, Chief Equity Portfolio Manager at Northwestern Mutual Wealth Management Co., stated:

"'Devaluation trade' has shown strong momentum this year, with assets like gold and Bitcoin generating substantial returns. The decline in real interest rates and the Federal Reserve's resumption of rate cuts amid persistently high inflation have added extra catalysts for this rally."

The U.S. government's shutdown that began on Wednesday has become a key factor driving Bitcoin prices higher. After lawmakers failed to reach an agreement on federal funding, investors turned to decentralized assets for safety.

Kendrick noted that Bitcoin's performance during this government shutdown is markedly different from the period from December 2018 to January 2019. He stated:

"During the last government shutdown under Trump, Bitcoin was in a different position and therefore performed mediocrely. However, this year, Bitcoin has formed a trading relationship with U.S. government risk, which is best reflected in its relationship with the term premium of U.S. Treasuries."Despite historical data showing that "devaluation trades" do not always accelerate during government shutdowns, analysts believe this event reflects deeper issues. Matt Stucky stated in an email to MarketWatch that the current government shutdown is "another data point in the ongoing dysfunction of the political system." He added:

"This dysfunction has led to federal deficits that consistently exceed normal levels during periods of economic expansion. High deficits and growing government debt are the consequences of decades of bipartisan cooperation, becoming an additional impetus for 'devaluation trades.'"

Jeff Muhlenkamp, a senior fund manager at Muhlenkamp & Co. in Pennsylvania, also believes that the government shutdown is merely a "minor episode" in the macro context, with the real issues facing the U.S. being more long-term structural problems.

Analysts Bullish on Outlook: Gold May Break $4,000

Market sentiment towards gold and Bitcoin is warming up. Citibank analyst Alex Saunders stated, Bitcoin is now seen as a "digital gold," which helps explain the correlation in price movements between the two. Based on sustained investor demand, he set a target price of $181,000 for Bitcoin within the next 12 months.

However, Komal Sri-Kumar, president of a consulting firm and former chief global strategist at TCW Group, prefers to view this trade through the lens of gold. He believes that while gold has existed for hundreds of years, it remains uncertain whether Bitcoin, as a new asset, can withstand market volatility. In his view, global tariff policies and the outlook for economic slowdown are eroding the value of various currencies, making gold highly attractive. He predicts:

"By the end of this year, gold prices will clearly break $4,000."

Fund manager Jeff Muhlenkamp also expressed long-term concerns about the dollar. He pointed out that the current deficit size, equivalent to 6% to 6.5% of GDP, has raised red flags. As a result, his company has increased its gold holdings to 18% over the past few years. Muhlenkamp believes that resolving the debt issue requires a reduction in the deficit-to-GDP ratio by 1.5% to 2%, which is unlikely to happen in the coming years. He stated:

"I think we haven't even begun to reduce the actual debt burden; it's still too early. We have a long way to go."