A warning from the goldmining boom to today’s cryptocurrency investors

The number of cryptocurrencies exploded as coders, entrepreneurs and scam artists jumped on the crypto-bandwagon. But as with a gold rush, fortunes can be lost as well as won.


The number of cryptocurrencies has exploded
(Image credit: 2018 S3studio)

Around about 2005-06 I started investing in gold. I can't remember the reason I bought my first ounce.

It might have been, simply, that I liked the idea of owning some gold. It was not the investment you "normally" made.

But the more I read, the more hooked on the subject I became, and the more I began to invest.

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The fantastic story that gave birth to the junior goldmining bonanza

There was an enormous narrative with gold.

"The monetary system is dysfunctional. Fiat money is backed by nothing. Governments print too much of it."

"There is too much debt. No fiat currency system in history has ever survived. Paper money will always go back to its intrinsic value: zero."

"Fiat money is doomed to die. The one true money is gold. The US dollar is going to collapse. It's inevitable."

"When it does there will be hyperinflation and gold will go to the moon. $5,000 gold, $10,000 gold name your price."

There was one particular narrative, perhaps the most enticing of all, that the US would, eventually, have to honour its debts with it gold.

The US has, today, $21trn of debt and 147 million ounces of gold. That would mean an approximate gold price of $143,000 per ounce. Gold was just $500 or $600 at the time.

Then came the argument that the US hadn't audited its gold in 50 years (it still hasn't, by the way). It was argued, compellingly, that the US might actually not have the gold it said it did. It had sold most of it during the late 1960s to try and prevent the run on the dollar.

"Mr President," said the US head of security, ran the joke, "there's no more gold in Fort Knox!"

"There's no more gold in Fort Knox?" came the president's worried reply.

"No, sir."

"Then double the guard!"

In such an atmosphere it was hard not to put everything you owned into gold. And as if to prove the argument correct, the gold price kept on going up. Every year saw 10%, 15% or 20% rises.

Investors couldn't get enough of it. They wanted greater leverage and greater gains. The market gave them what they wanted. And so we saw the emergence of the junior mining company.

The three types of mining company

In simple terms there are three categories of mining company.

There is the producer: often a large company with one or several mines already producing gold, usually at a profit the likes of Barrick and Newmont.

Then there is the development play. This might be a company that has made a discovery. It is now, by drilling, defining the amount of gold it has and perhaps actually building a mine. A mine takes many years to build, often as many as ten. It takes a lot of capital investment and it is often a long wait before that capital sees any return.

Finally, there is the explorer. This is usually a small-cap stock. It has staked some land somewhere. For some geological reason it suspects there might be gold there, and it has a small amount of money with which it is going to drill that property. It's a gamble on the drill bit, basically. Something like one in a thousand companies make a successful discovery.

Such was the speculation that millions of dollars got thrown at the entire sector, most of it on the underlying assumption that gold would keep going up. Development plays, even though they could only mine profitably at $2,000 an ounce, were priced as though gold would be even higher.

Exploration plays, meanwhile, were given extraordinarily high valuations. Directors of small caps, when they should have been conserving capital, were driving Ferraris, dining at the Ritz and sleeping at the Savoy.

Then gold, in August 2011, stopped going to the moon. It range-traded for a year or two, then, in late 2012, it began to hit the skids.

From the high ($1,920) to the low ($1,050) it lost something like 45%. The losses were bad, but given the gains that had preceded, most people who had bought gold and only gold (particularly if they used sterling) did not totally lose their shirts.

Where shirts and more were lost was in the mining companies. Share prices fell by over 90% in many cases. Companies that were trading at $1 were now trading at 5c. Their projects were worthless. Investment dried up completely. They had no capital. Many companies went bust. The sector still has not recovered.

A warning for investors in tiny cryptocurrencies

Altcoins are the junior miners of crypto. Looking through coinmarketcap.com, I see there are now 1,969 altcoins. By the time you factor in all the ICOs (initial coin offerings the crypto version of an IPO, basically) there are probably many more.

Most were born out of the underlying narrative of bitcoin: here is a new and better money system that is going to change the world. Some altcoins are legitimate operations with some genuine application. Many are not.

In the bull market, their early adopters were driving Ferraris, dining at the Ritz and sleeping at the Savoy. Some still are. Without massive adoption, the crypto-equivalent of striking gold, most of these have no raison d'etre. And although the number of these coins that make it will be greater than the one in a thousand seen with junior miners, the hit ratio will still be low one in a hundred maybe?

And as with junior mining, there are scams galore. However, there are plenty more legitimate operators coders/geologists genuinely trying to develop something viable. But the bottom line is that their project simply won't cut the mustard. If the gold/adoption isn't there, it isn't there.

Having lived through the mining bear market, I wonder if many of those in crypto space are aware just how bad a bear market can get. We need bubbles. That's how the infrastructure gets built. But we also need bear markets to then flush out the space.

I don't think the crypto bear will be as long or as grim as the mining bear. The sector is too young and dynamic. There are too many fantastic things being built. This is a breakthrough technology.

The United Nations recognises 180 different currencies around the world. 1,969 altcoins is too many (even if not all of them are intended to be currency). The level to which many of them will decline is, just like paper, their intrinsic value: zero.

Dominic Frisby

Dominic Frisby (“mercurially witty” – the Spectator) is the world’s only financial writer and comedian. He is MoneyWeek’s main commentator on gold, commodities, currencies and cryptocurrencies. He is the author of the books Bitcoin: the Future of Money? and Life After The State. He also co-wrote the documentary Four Horsemen, and presents the chat show, Stuff That Interests Me.

His show 2016 Let’s Talk About Tax was a huge hit at the Edinburgh Festival and Penguin Random House have since commissioned him to write a book on the subject – Daylight Robbery – the past, present and future of tax will be published later this year. His 2018 Edinburgh Festival show, Dominic Frisby's Financial Gameshow, won rave reviews. Dominic was educated at St Paul's School, Manchester University and the Webber-Douglas Academy Of Dramatic Art.

You can follow him on Twitter @dominicfrisby