Bitcoin as Crisis Hedge: Correlations with Leading Stock Indices in Q1 2020
Bitcoin was positively correlated with the leading stock indices in Q1. Still, the asset has proven its worth for portfolio diversification. A closer look at correlations, Bitcoin’s price behavior, and lessons learned from the COVID-crisis.
Bitcoin aficionados have positioned the asset as the “digital gold,” because of its limited supply and non-correlation with other asset classes. Just like gold, Bitcoin may work as a portfolio hedge during crises – so the argument. Then COVID struck, and Bitcoin had a chance to prove its worth.
When stock markets plunged at the end of February and early March, Bitcoin lost massive value and its function as a crisis hedge was called into question. But looking back from today’s perspective, Bitcoin has been an excellent diversification instrument during the crisis.
During crises, all correlations go to one
The sharp decline of stock markets in February and March were cause by a liquidity crisis. Fearing the economic consequences of the COVID-19 pandemic, investors panic-sold their assets. As there were not enough buyers in the market, sellers had to lower their prices even more and the resulting downward spiral pushed prices lower until central banks intervened and provided liquidity.
In this situation, investors sold all liquid assets, whether it was stocks, Bitcoin, or gold. In a liquidity crisis, the correlations of all asset classes go to 1, and Bitcoin is no exception – nor is gold.
Between February 19 and March 23, 2020, Bitcoin was therefore positively correlated with leading stock indices. The correlation with the Nikkei 225 was about 20% higher than the correlation with the S&P 500 and FTSE 100.
Looking at historical correlations between Bitcoin and the leading stock indices, February and March 2020 were clearly an exception. Throughout all of 2019, the correlation was significantly lower.
Correlations were particularly high during trading hours
The correlations also differ across the different trading hours. While shares can only be traded during the opening hours of the respective stock exchanges, Bitcoin trading is possible around the clock.
The correlations between Bitcoin and stock indices are particularly high during regular market trading hours and have increased significantly in early 2020. High correlation during trading hours could be an indicator of increased institutional investment, as institutions invest mainly during trading hours.
Bitcoin has recovered faster than stocks
Looking at April and May prices, Bitcoin has recovered faster than all stock indices and is now at about the same level as before the crisis.
So far, Bitcoin has proven its worth as a portfolio addition during the crisis. Although the asset does not protect against short-term liquidity-driven sell-offs, it recovers relatively quickly from market shocks compared to other asset classes.