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This article seeks to answer the question, what is the biggest investment opportunity of 2020? First and foremost, you are not likely to find it in the stock market with current frothy conditions.

Bonds and gold provide decent opportunities. If you believe that we are in the late stages of the business cycle, being long bonds is the best way to articulate that view without taking the outsized risk of shorting equities. Meanwhile, negative yielding bonds in Europe and Japan, geopolitical tension, and foreign central bank demand have created the perfect storm for gold prices.

Commodities are inexpensive, but if global industrial production continues to lag, base metals and other commodities will remain cheap. For context on lagging industrial production, the current print on the ISM is 47.2. There has been a 65% chance of recession whenever the ISM dropped below 50, and a 100% chance whenever the ISM crossed below 46. Despite this, neither stocks, bonds, gold, nor commodities offer the same risk/return profile of the asset class I am about to propose.

The biggest opportunity of 2020 and beyond is Bitcoin. Bitcoin's stock to flow (SF) ratio has a 95% coefficient of determination, or R-squared, with the price per coin. In plain terms, 95% of the variation in the historical price of Bitcoin can be explained by its stock to flow (existing stockpiles/yearly mining) ratio. Only 5% is determined by other factors such as regulations, adoption rates, and news surrounding Bitcoin. This model has Bitcoin's fair value at $55,000 by May 2020 due to the upcoming halving.

My first impression was incredulity. For a regression analysis on the price of an asset to be that parsimonious seems too good to be true. Yet both individual statisticians and institutional investors have confirmed the validity of the model. Surely, the model can break down for currently unforeseen reasons. I would not suggest levering up or putting most of one's portfolio in any cryptocurrency. However, the risk versus reward is highly asymmetric. Investors risk losing principal in order to gain 10x or more.

There are three primary ways to think about Bitcoin. The first is as a disintermediary in the financial system. Before Bitcoin, no mechanism existed to transfer value over a communications channel without using a third party. Peer-to-peer transactions on a distributed ledger reduces the time and transaction costs associated with online payments going through a bank or other trusted central authority. The largest issue with online coins is preventing double-spending, a flaw whereby someone can falsify and spend the same coin multiple times. Bitcoin's proof of work system prevents double spending. The Bitcoin ecosystem also aims at privacy with all transactions displayed using anonymous public keys and security through decentralization.

The second way is as a superior form of money. My previous Bitcoin article sticks exclusively to this realm. Essentially, it serves as a greater medium of exchange than gold because it can be sent instantly and as a greater store of value than the dollar because it is not subject to fabrication from Central Banks.

The final way to think about Bitcoin is digital scarcity as its enigmatic creator Satoshi Nakamoto explains:

"As a thought experiment, imagine there was a base metal as scarce as gold but with the following properties: boring grey in colour, not a good conductor of electricity, not particularly strong [...], not useful for any practical or ornamental purpose ... and one special, magical property: can be transported over a communications channel."

The mining process of Bitcoin is akin to gold and silver in that it requires time and energy, but through computational power and electricity instead of labor. After satisfying the proof of work requirement, a miner is rewarded with newly created coins. The number of coins rewarded began with 50 and is halved every 210,000 blocks, or roughly four years, until the stock reaches 21 million coins. That means every four years, the stock to flow ratio doubles, and price moves exponentially higher with increases in SF. The chart below shows price action with previous halvings.

(source: "Modeling Bitcoin's Value with Scarcity")

The SF model holds true for gold and silver prices as well. Gold, silver, and Bitcoin trade very similarly based on scarcity dynamics. That's why from a valuation perspective, perhaps the best way to think about Bitcoin is digital scarcity.

(source: Ibid.)

Thus far, I have presented the fact that the SF model has a 95% correlation coefficient with the price per Bitcoin. I have also presented the fact that the SF of Bitcoin will double in May of this year. A model with 95% accuracy up to this point stating that the price of an asset will move exponentially higher within the next few months is worthy of some attention. And while critics object that Bitcoin is too risky, the chart below shows that historically, a 1% BTC/99% cash portfolio would have outperformed any asset class while taking next to zero risk.

(source: "Efficient Market Hypothesis and Bitcoin Stock-to-Flow Model")

The SF model is credited to both Saifedean Ammous, author of The Bitcoin Standard, and Plan B, an anonymous quantitative institutional investor from the Netherlands. Plan B highlights and addresses two major objections to his model. Firstly, halvings should already be priced into Bitcoin as all information is priced into an asset according to the Efficient Market Hypothesis. The counterargument goes that despite the public availability of the model, most investors overestimate the risks associated with investing in Bitcoin. These risks include hacks to exchanges, a superior coin entering the market, governments making Bitcoin illegal, etc. While reasonable risks, these objections have been used since Bitcoin's infancy.

According to the model, Bitcoin will achieve a market capitalization of $1 trillion after May 2020. The question is, where will all this money come from? Plan B cites some examples as follows: "silver, gold, countries with negative interest rate (Europe, Japan, US soon), countries with predatory governments (Venezuela, China, Iran, Turkey, etc.), billionaires and millionaires hedging against quantitative easing (QE), and institutional investors discovering the best performing asset of last 10 yrs." I have a few important facts to add.

The world is awash with liquidity due to Central Bank policies. The world is also awash with investors seeking yield and undervalued assets in the current "everything bubble." Bitcoin is already in the top thirty global currencies by market cap. With a greater market cap than the Colombian peso and the New Zealand dollar, there is no denying that Bitcoin plays a role in the global macroeconomic landscape. As it moves higher as a share of global currencies and assumes a larger role in the future of the financial industry, more institutions will find themselves buying.

Regardless of one's personal opinion on the future of this asset class, enough quantitative evidence exists from Bitcoin's decade of existence to suggest that it has a role to play in everyone's portfolio.

Disclosure: I am/we are long BTC-USD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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Bitcoin: The Biggest Opportunity Of 2020 - Seeking Alpha