How Durability and Storage Costs Relate to Inflation Hedging

It's becoming increasingly clear that the monetary inflation that we've seen over the last year is finding its way into price increases on commodities. We can no longer point to falling prices of raw materials as evidence that monetary inflation is contained and managed so as to lift the prices of financial assets, but not prices of more ordinary things such as oil, lumber and copper.

Investors now see opportunities in buying commodities as hedge against monetary inflation. Interest rates are so low that the opportunity cost of holding onto a bunch of copper or other raw material is low, especially with the price of almost everything else at record highs.

This has resulted in a trend reversal in the price of commodities. Traders who have not yet made the transition from financial assets to commodities are underperforming colleagues who have. Adding to this the clear intention by governments to accelerate monetary inflation into the future, more and more people look to commodities as sensible hedges for their portfolios. However, this brings up two problems that traders in financial assets rarely think about.

1. How to keep their commodities fresh
2. Where to store them

A simple way to deal with the first problem is to buy things that stay fresh on their own. Durable commodities such as oil, lumber and copper are therefore preferable to pork, fish, eggs and milk.

A simple way to deal with the second problem is to buy stuff that takes up little space, or things for which storage space is plentiful and easy to find. Oil is therefore preferable to coal or gas, lumber is preferable to bricks or gravel and copper is preferable to iron.

The ideal commodity in this respect would be something that takes up no space and for which there is no storage cost, and many have mistakenly identified Bitcoin to be of this kind. The fact that Bitcoin can be held as a code outside the web, safely locked away somewhere secret, makes it appear as if it has no storage cost. However, the code is only part of the Bitcoin eco-system. The data that it represents must be stored on network computers, and these computers require energy and maintenance. Unfortunately for Bitcoin owners, neither the data stored nor the cost of storing it is under their direct control. Both the equipment and the cost of operating it are responsibilities of Bitcoin miners who must sell Bitcoin in order to pay their bills. Millions of dollars must be procured every month for this purpose, making Bitcoin ownership a lot more precarious than it may seem.

If Bitcoin miners go broke or give up, Bitcoin owners will find themselves holding nothing but worthless pieces of paper with codes written on them. However, gold has value regardless of what happens to gold miners. Gold is also infinitely durable and easy to store.

The storage cost for Bitcoin only appears to be near zero, while the storage cost of gold held privately really is near zero. It is therefore gold, rather than Bitcoin, that has the smallest storage and maintenance cost. Once this becomes clear to inflation hedgers, we will see gold once again outperform Bitcoin. There's only a matter of time before this happens, because the hidden cost of owning Bitcoin will sooner or later reveal itself in the form of overwhelming selling pressure. It's impossible to predict when this will happen, but given the power hungry nature of the Bitcoin network, the trigger for such a sell off is likely to be a spike in the cost of energy.

Cryptocurrency mining farm

By Marco Krohn - Own work, CC BY-SA 4.0, Link