The bitcoin bubble will burst: here’s how to play it

One of my most successful tips has been shorting bitcoin. If you had taken my advice to sell it short in January 2018 (issue 880), you would have made a profit of £1,744 after closing the position in April 2019. I then suggested shorting it again in July 2019, which would have produced a small profit of £250 after the position was closed in January 2020. However, over the past year the cryptocurrency has been on a tear, rising from just under $7,000 at the beginning of April 2020 to the current price of $58,000. So is this surge due to a genuine shift in the fundamentals? Or will history repeat itself?

Many people clearly believe there have been two major changes in the fundamentals of the currency justifying not only the higher price but also further sharp appreciation. First, there has been a big shift in official attitudes to digital currencies, with central banks viewing them as the future of finance instead of a threat to their power.

This acceptance has been mirrored by investors with an increasing number of institutions, not just retail investors, starting to dabble in them. The various fiscal and monetary packages launched by governments in the wake of the pandemic have also fuelled fears of an inflationary surge. Bitcoin is seen as a hedge against price rises since unlike paper money it cannot be reproduced easily (there is a fixed amount of it).

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Central banks are still wary

I’m not so sure. While several central banks have become a lot more interested in the general idea of digital currencies, especially in terms of facilitating payments, they remain deeply sceptical about bitcoin, with both the European Central Bank and the Bank of England calling for tighter regulation. Indeed, if anything the Bank of England’s plans for its own digital currency give it a strong incentive to discourage independent currencies such as bitcoin. At the same time, most of the corporate interest in bitcoin has been from a handful of hedge funds and technology companies such as Tesla (and you could argue that Tesla’s investment is a publicity stunt).

You could even say that the fact that several long-time bitcoin sceptics have become bitcoin bulls, with JPMorgan predicting that it could reach $130,000, is a classic sign of “capitulation”: a red flag that the market has reached its peak. Meanwhile, bitcoin, like most digital currencies, still suffers from the fact that it is a poor method of exchange (as it is difficult to use it in everyday transactions) as well as a lousy store of value (owing to its extreme volatility).

Given that it is impossible to predict when this bubble will end, I wouldn’t short bitcoin now. Do what we did towards the end of 2017 and wait until it has fallen substantially – below $40,000 in this case – before shorting it. Do so at £50 per $1,000, covering your position if it rises to $59,000, giving you a total downside of £950.

Trading techniques: shorting SPACs

Until recently companies that wanted to be listed on the stockmarket would offer shares to the public in a flotation, or initial public offering (IPO). This is usually a protracted and expensive process (investment bankers charge high fees), while the company also has to disclose detailed financial information.

As a result, many companies, including technology firms, are increasingly going public by doing deals with special purpose acquisition companies (SPACs). SPACs, sometimes known as “blank cheque companies”, are shell firms floated on the stock exchange with no underlying business except to buy other companies.

In theory, being bought by a SPAC is a much cheaper and quicker way for a firm to achieve a stockmarket listing than with an IPO. However, an increasing number of experts are warning that these deals are generally poor value for investors in the SPAC.

This is because the lack of transparency makes it much easier for the companies being taken over to hide serious problems with their business that would otherwise be revealed during the process of going public. Many recent firms going public via the SPAC route, such as WeWork, which recently agreed a deal with BowX, were unable to withstand the scrutiny of the traditional IPO.

A study by Stanford and New York universities would seem to bear this out. Having examined the post-merger share price of 47 SPACs between January 2019 and June 2020 they found that the SPACs lagged the market by an average of 2.9% three months after the merger, 12.3% six months later and 34.9% 12 months on. This suggests that it might be a good idea to short the shares of SPACs after a merger takes place.

How my tips have fared

The past fortnight has been kind to my five long tips, with four of them climbing. Transport group National Express rose from 297p to 331p, cruise-ship operator Norwegian Cruise Line increased from $28.35 to $29.71, American homebuilder DR Horton climbed from $84.49 to $92.64 and construction firm Morgan Sindall Group jumped from 1,686p to 1,804p. The only share that didn’t appreciate was media group ITV, which remained unchanged at 122p. Overall my long tips are making total net profits on £6,686, up from £4,531 a fortnight ago.

My five short tips have also gone in my favour, with three out of five falling. Electric-lorry manufacturer Nikola fell from $15.55 to $12.83, online grocer Ocado went down from 2,068p to 2,059p, and electric vehicle maker Plug Power declined from $38.91 to $33.44.

Cloud computing firm Snowflake rose from $221 to $233, while eHealth rose above $74, which is the point at which I suggested you cover your position. Counting eHealth, the total net profits on my short tips are £2,918, up slightly from £2,691 previously.

Including this week’s bitcoin short, I am now carrying ten tips forward: five long tips (National Express, Norwegian Cruise Line, ITV, DR Horton and Morgan Sindall Group) as well as five shorts (bitcoin, Plug Power, Ocado, Nikola and Snowflake).

As this is a good balance, there is no need for me to close any additional positions, especially since they are all making money. However, I do think that you should adjust some of the stop-losses to lock in some additional profit.

I suggest you increase the stop-loss of ITV to 95p (from 90p), National Express to 290p (287p), Norwegian Cruise Line to $23 ($21), and DR Horton to $62 ($60).