A Talk with Former Morgan Stanley Man Tom Meyer

Wednesday, 20 January 2021
Wollongong, Australia
By Greg Canavan

[3 min read]

In Monday’s Insider I mentioned that I understood the reasons behind Bitcoin’s [BTC] rise, but I had no idea about its proper value.

To be fair, I don’t think many others do either. We’re in the ‘price discovery’ phase, which means the market is in the process of working it out.

In today’s update, I want to try and give you a basis for understanding bitcoin’s value.

I did this exercise with gold years ago. As bitcoin is in some ways an electronic version of gold, I thought it might be useful to do the same exercise.

Let me show you what I mean…

We’ll take a look at gold first.

From a rational perspective, the absolute minimum value for an ounce of gold should be somewhere around its cost of production. If prices fall below there, production will cease. Maybe not straight away, but as prices decline, the marginal producer starts losing money, so it’s just a matter of time.

According to the World Gold Council’s Gold Hub, the average all-in sustaining cost of production (AISC) for the global gold industry is just under US$1,000 an ounce.

Does that mean this represents a starting point for the base value of an ounce of gold?

Not quite.

US$1,000 an ounce is just an average production cost. The Gold Hub data also shows that if prices fell to US$1,000 an ounce, it would take out nearly 50% of the world’s current gold production.

A closer look shows that just over 90% of current gold production occurs at a cost of around US$1,500 an ounce. So if prices fell to that level, it would knock out around 10% of current gold production.

While it’s an arbitrary guess, in this monetary environment I’d be prepared to say that is close to an ‘intrinsic value’ or floor price for gold. That’s not to say it couldn’t fall below that level. But it would be unlikely to stay there for too long. The economics just don’t stack up.

From that floor price you add on what I call a ‘premium’. That is, gold is an insurance play against currency debasement and a broken monetary system. To make things annoyingly difficult, the premium is whatever the market decides it is.

With the gold price currently trading around US$1,850 an ounce, that premium is around $350 an ounce, based on my analysis above.

In my view, this is a pretty thin insurance premium given the economic problems the world faces. It could be wrong on that assessment. The market is telling me I am at the moment. But let’s wait and see…

How does this stack up when it comes to bitcoin?

Well, I asked our crypto expert Ryan Dinse what the numbers were. And this is what he came back with…

Bitcoin mining costs are not that easy to quantify as they vary from miner to miner mostly depending on location.

That’s because the primary cost — once you have the hardware — is electricity costs (interesting that energy and money are linked in crypto, just as they are in the petrodollar).

As this article states:

“In 2018, the cost to mine one Bitcoin in the US was $4,758, meanwhile in Venezuela it was just $531 per coin. If you wanted to cross the pond, you would find it was more expensive at $8,402 per coin in the UK and over $13,000 per coin in Belgium.”

It’s worth pointing out that mining hardware depreciates fairly fast too as better mining rigs are produced. Though these rigs don’t do anything that complex, they just provide a lot of “grunt” to keep guessing the answer for each block.

So, if you assume roughly US$8,000 as an average cost to mine one bitcoin (plus amortised hardware costs) then you can see that at current prices of US$32,000 per BTC, miners should be doing quite well.

But as there are no barriers to entry here besides time to set up a new rig (and source equipment) — so some lag — then you can expect more miners to come in.

This process will show up in the bitcoin difficulty chart — namely, the difficulty level will increase as more miners join the hunt for BTC blocks.

The beauty of the BTC system is that as more miners come in the difficulty level increases making the whole system more secure (costly) from attack. That positive feedback loop between price and security is one of the most innovative things about BTC.

So, like gold mining, with bitcoin there are different mining costs for different mining locations. Like Ryan said, if we assume an average cost to mine of around US$8,000, at current prices miners are doing very well.

It also suggests that at current bitcoin prices, there is a good insurance premium priced in for monetary instability.

Or maybe not. I could be completely wrong about that. I’m trying to think logically about pricing, but as you know, the market rarely thinks about anything logically.

As I said earlier, bitcoin is in the price discovery phase. This is likely to continue for a few more years yet. In the meantime, expect lots of volatility. Expect to hear that it’s going to zero and that it’s going to the moon. At times, it will feel like both views are right.

I think you’ll do well by betting against both those views at the right time.

The way I see it, bitcoin and crypto are here to stay. It’s a free market response to a broken and corrupt system of finance. The collective mind doesn’t want their labour and capital denominated in a depreciating currency, managed by tyrants and thieves.

This is why capital will continue to migrate into this new currency system.

If you want to follow along, and trade through the ups and downs, you absolutely must follow the work of my colleague Ryan Dinse. He saw this coming well before most people. And certainly well before me.

Recognising the inherent volatility of a newly developing currency system, Ryan devised a way to trade the crypto market years ago. He does this by moving in and out of bitcoin and various other cryptos, depending on their movements relative to each other.

It’s unique, and can potentially deliver big gains in a short amount of time.

To find out more, go here.


Greg Canavan Signature

Greg Canavan,
Editor, The Insider