RAOUL PAL: Hi, everyone. I wanted to give you an update on crypto because I think there's some really interesting things going on. And I want to get across the importance of the Eth merge, and a whole bunch of other stuff. And I think it's a good time to do it. So, what's happening in crypto right now is I think we're in a bottoming process and have probably bottomed. And I'm going to talk you through my reasonings for that. And, more importantly, how macro fits into this, because many of you are crypto people and now, you're learning that macro is a really important thing.
And actually, this is one of the reasons we set up that whole real investing course, to teach people about macro and investing, so you get a better understanding how to do it. But the macro right now is very important. So, I'm thinking that economic growth falls off a cliff, I put out some tweet threads about this. I've talked about it on the Daily Briefing. 've been talking about it for some time and writing about it in Macro Pro.
Now, if I look at this chart, this is an indicator that we've constructed at GMI, which uses the rate of change of interest rates, commodities, and also the dollar. And it leads the financial conditions index, it leads the Goldman Sachs financial conditions index, and suggests that we're about to go into a short, sharp recession. And that the ISM, which is my best guide to the business cycle, is going to fall sharply down to something like 35, which is a decent sized recession.
Now, this indicator is already picking up, which means that it leads by nine months. So, therefore in nine months, we should start to see a sharper turnaround. Now, we can't always tell how this plays out. But that's my best guess, like a 1974 style sharp recession, recovery backup. And I think asset prices bottom well before the economy. 2018, they bottomed pretty much a year before. And in other periods of time, it tends to bottom six months or so before.
So, I'm thinking we're close to the bottoming phase in markets overall. Equities might have another stab lower. Because I think they're not fully priced in. They're pricing in about, let's say 45 on the ISM. That's what the S&P is doing. NASDAQ's probably about 40. So, that's starting to price in a reasonably severe recession. 47 is about a recession in ISM levels.
And if I look at the further end of growth stocks that I call the exponential age stocks, they're pricing in somewhere around 30. So, a really severe recession. So, the markets are pricing it in, now crypto has been picking up. Now it's interesting, because most people don't understand that macro and crypto are so related, because crypto is this network adoption model that I'll come on to in a bit. But really the big cycles, I'm starting to think they're not driven by the halving cycle, so much as the macro cycle.
You see ISM is coming lower. We can see this also for the next one, which is the new orders minus inventories, it's less forward leading, but it shows us maybe in the next month or two, that ISM is going to fall pretty sharply. Okay, that's interesting, because what we find is the biggest macro influence on crypto is the global money supply. So, this is M2 year-on-year, and this chart shows its correlation to the crypto markets overall.
So, this is the crypto market cap versus global money supply. And you can see the cycles are the same. Now, that makes sense to me. It might coincide with the halving cycle. And that makes a supply issue plus a demand issue. Why a demand issue? Well, because global liquidity is what M2 is. So, if there's more liquidity, there's more money that flows into crypto. As liquidity comes out of the system, there's less money.
One of the other things that's been weighing on crypto has been inflation, it's a long duration asset, and long duration assets need to worry about the discount rates and inflation is part of that. Plus interest rates, interest rates have risen, inflation has risen, risk assets get discounted more. So, we've got to that but I think you can understand by now, I think we're at the big turning point in the economy where inflation starts falling, but growth collapses.
That brings down yields, and if it brings down yields, it starts allowing stuff further out in the duration curve like 10-year bonds, 30-year bonds, technology stocks, and really crypto because it's the most forward longest-term asset of all to start outperforming. So, I think we're starting to form a base based on the macro. Now to bring it back to why the ISM matters, as you can see from the next chart, ISM actually leads it, leads money supply.
So, in this chart, ISM is inverted and the money supply looks like it should start bottoming out and going higher. If it goes higher, crypto should go with it. Now, that makes sense because as economic weakness comes, the central banks start coming into play, liquidity starts being pushed into the system. We're already seeing it in China, that's probably picking up the money supply growth already. But I think we'll see it globally. So, that becomes interesting.
The US dollar situation, maybe we see swap lines, that helps money supply. So, I think we're going to see the turn in money supply. So, that's the macro for crypto improving as growth goes slower. It's counterintuitive, because you think, well, if growth slow, then crypto is going to be bad. It's the opposite. As growth slows down, bond yields fall, inflation falls, money supply starts increasing, crypto starts doing well.
So, what this is, is a gyration within the long-term trend adoption of crypto. So, this chart is the chart I always show which is the log regression chart of Bitcoin. And what you can see is in the log regression chart, it gets a roughly two standard deviations oversold, which is actually about the most oversold Bitcoin's ever been versus its trend. So, we should be looking at a reversal point because the exponential trend of adoption is not going away. It's not changing.
In fact, the adoption in this bear market has been much better than the previous bear markets where we saw a lot of people leave. We've not seen a lot of people leave, we've just seen network activity slowed down, because there's less money around, because of money supply and inflation. So, I'm looking for the turn here. The other long-term indicator I use is the five-year exponential moving average. And this has encapsulated the trend of Bitcoin pretty much since the beginning.
And here we are, just touching that trend. We broke through it, I think we broke back up through it. So, again, this is the buy zone. You buy these times, and this is where you make the larger returns. The risk reward gets better and better and better the closer to that two standard deviations oversold, the closer to this exponential moving average. That's the really good risk reward.
What's the downside? 30%. What's the upside? 10x. So, those kind of risk rewards are super rare in almost any asset class, but they are in crypto. And we're in that zone now. And I'm getting more and more comfortable with that. If for example, I look at the RSI for Bitcoin, the RSI for Bitcoin is the most oversold it's ever been. So, that would suggest that the markets are massively oversold. So, again, the risk reward looks better and better here.
It's actually the same for Ethereum. Ethereum, lowest RSI in history, obviously, everything's starting to pick up as we've had this tremendous rally from the lows, which still looks small on the chart, but it's actually, some of these tokens are up 100%. And when ETH was up at the top of this run at 85%, that's pretty decent. But I think it's just the start. We're in the correction phase right now, because we've got overbought, but I think the correction doesn't last long before we go to the next leg higher as we start moving into the merge which this piece is going to be mainly about when I get there.
Another chart that shows us where we are is the Bitcoin rainbow price chart. I love this chart, it gives the logarithmic trend, but instead of the linear version, it gives you the log version. And it's a curve. And again, we're at the point where you want to be buying assets. It never gets through here. And if it does, it's for very short periods of time. That same rainbow works brilliantly for Ethereum too, and here we are, exactly in the buy zone where we should be finding any cash we can to put into crypto according to your risk tolerance.
When I've again, still pretty much 100% allocated and any income that I've got, spare income, I'm putting into crypto right now because I think the risk reward here is extraordinarily attractive. Another way of looking at it is on chain activity in the Bitcoin dominancy flow, which here was provided by Fidelity. Again, it's showing levels that are supremely oversold, these on chain indicators are all over the place showing exactly the same thing, is this is the level that we should be looking to aggressively accumulate crypto.
And again, because of the macro, because of the price structure, I'm starting to get incredibly excited again about what crypto could do. Now, a lot of people say, yeah, but it's got another leg lower to come. Well, if I look at the crypto fear and greed index, it got to six, this is the lowest I've ever seen it get to. So, basically, everybody's bearish, everybody was expecting another selloff down to 15,000, 10,000. Is it possible? Of course it's possible, but I don't think it's the highest probability.
Could we have a new low? Yes. I still think that's probably maybe a 40% chance, 35% chance. I think the low is in, and anything from here is a retest of that low but I could be wrong. Anyway, it's still a zone. If you say 30% downside, 40% downside, 10x upside, that risk reward, I'll take it all day. Also, news flow. If you look at this article from The Guardian, this is typical of what you get to at this stage in the cycle. It's all a scam. It's all a Ponzi. See, we told you so.
You see, because what they look at is the selloff. It's down 85% or 80% or depending on what token, 65%. But what they don't look at is that network log adoption. You see, the next chart shows you the most important thing, is every low is significantly higher than the previous low. So, yes, there are cycles. But this ain't oil, where it goes up and down cyclically, it goes up and down cyclically in a secular exponential trend.
This is about the most important thing I can express to you about the cryptocurrency markets. This is network adoption, Metcalfe's law. So, when you get this cheap versus Metcalfe's Law, this is the time you start to invest. This other chart has been around since 2014, and it was using again, like that Bitcoin rainbow, using that log curve to show you where it could go for network adoption models. And it's been following this really well. Back in 2014, it was predicting prices for 100,000, or for about 2020, 2021. Now, we didn't quite get there, but it's roughly in line with this trend and it should keep going as the trend keeps accelerating.
And I think it makes sense to me, because all we're doing is looking at a network grow. So, I think a lot of this activity is getting very interesting. If I start looking at price, we've talked a bit about Bitcoin, but if I look at the chart of Ethereum versus Bitcoin, to me, it's very close to breaking out of this downward channel. And as you know, I've been overweight Ethereum for a long time now, and it's paid off very well. And I expect it to have another leg higher. So, I'm more interested in Ethereum than Bitcoin.
That's not a from a philosophical standpoint, I think Bitcoin's bad. We're here to make money. And we're here to try and capitalize on the growth of digital assets and Web3, and Ethereum looks like it's a better bet. I think there's some tokens, many tokens will outperform Ethereum, I think Solana might, I don't know. I might be right, might be wrong, but Ethereum, I'm very comfortable that it should do extremely well and should outperform particularly with what's going on with the merge.
Now, if I look at the price action of that spread, the ETH/Bitcoin cross, it put in a weekly DeMark low, that's a great segment and exploded higher from that, I think it might retest the top of that channel, pull back as ETH corrects a little bit and then explode higher again. So, that's the kind of price action, it's confirmed by my DeMark indicators, which I really like as well. And the chart pattern is particularly good.
When I look at ETH on its own, it put in a weekly 9 and 13 low. That's a really strong signal of trend reversal, not just a correction trend reversal, which is why I started accumulating much more Ethereum over the last month or so, because this signal was in place. This signal in place was my go, because it was exactly the right point, the exponential moving average, the logarithmic curve, the on-chain activity, the RSI, now, I've got so many indicators suggesting this is the point.
So, why Ethereum? Now, apart from the charts, is the merge. The merge is probably the single most important thing that I can think of that I've seen in crypto since the invention of stablecoins, and the launch of ETH itself. Now, that's quite a big statement. And there are risks that it doesn't work fully, I get that. I'm prepared to take the risk, because I think it will. You may not be prepared to take the risk, and that's fine, too.
So, let's talk about the merge. So, first, we need to go back in time a little bit. We go back in time to the burn. So, this is the EIP 1559. And what that did was change the dynamics of ETH that burnt using network activity, that burnt ETH. Now, it reduced the supply of ETH by about 65%. And in a strong demand environment, supply reductions are important. They're not in most other times, but really when demand meets reduced supply, then things get interesting.
So, ETH massively outperformed Bitcoin, because of this activity, because the ETH network has been used for defi, NFTs, all sorts of stuff. And with reduced supply, the price went up faster. That makes total sense to me. But the merge is something much bigger overall. The merge is where Ethereum goes to proof of stake as opposed to proof of work. So, now you're not having computers crunching the maths and being rewarded as miners for doing the work.
What you're doing is you're pledging your Ethereum for a year to secure the network. And that's called staking and staking participates by you getting a yield for doing that, which is staking your coins, i.e., you can't use them, and you get a return. So, I'll come on to that in a sec. But what's really interesting here is this is a supply reduction of really monumental proportions that's about to happen. Now, I'm more of a demand side person than a supply side person, but when demand and supply are both in shock, okay, then we got something interesting.
So, what's with the supply side? Well, miners, there are no miners anymore. So, therefore, all of the activity of miners of selling the tokens that they've earned, they probably sell about 80% of the tokens that they get just to fund their own activities. That's about a billion or 2 billion a month, that's out of the market. So, that's a small supply shock. There's no ongoing pressure every day from miners who've been rewarded with Ethereum. So, that goes, okay.
Then the staking activity, there's currently about 9% of all Ethereum staked, by most guesses, that number should rise to about 30%. Because initially, we should see some outsized deals maybe up to as high as 20%, maybe it's 15%, who the hell knows. But either way, it's going to attract a lot of capital into staking. And so, that becomes very interesting itself, because if it gets up to 30% of all ETH staked, that's 30% that is dormant. That 30% cannot be used for defi, cefi, rehypothecation, shorting, liquidity provision, nothing, it's out of the system. Okay, that is a massive supply shock.
Then on top of it, ETH staking gets its yields from network activity. So, as the network is active, it generates the yield. Add that to the burning for the network activity as well, and what you get is actually something that looks like it's going to be deflationary, i.e. there's going to be less ETH every day than there was the previous day. So, that itself is really interesting. So, as opposed to a daily sell pressure of excess ETH in the market, it becomes a daily buy pressure.
Now, this might sound familiar to you, because this is very similar to buybacks and dividends. So, buybacks and dividends are very predominant in the US. It's one of the key reasons why the US markets have outperformed other markets. There are dividends, not mainly in tech stocks, but other stocks has a lot of dividends, but buybacks are very big because of the tax breaks.
So, if you keep reducing the supply of equities by buying them back, you generate demand and reduce supply. So, then in normal economic times, you find that the markets because there's less equities around because the market cap, the divisor for the index, there's less around so therefore the index goes up more. That's a natural function. When you add stuff like ongoing demand from 401Ks and passive flows, it creates this outperformance that the US has enjoyed for so long outside of the fact that technology has been the home in the US and it's had better equities and stuff like that. But there's this supply and demand dynamic of buybacks plus dividends.
And you can see that the impact on price from this chart now, it shows that they're very correlated, because it is just a nice dynamic that helps price performance over time. So, we've got that. So, this is the supply starting to move into demand. But there is a demand shock coming. One is the macro cycle. The macro cycle is turning. So, therefore demand is going to come back as liquidity comes back.
Secondly, ESG. Now whether you agree with ESG narratives or not, it's real, and there are mandates built on it, particularly in Europe, but increasingly in the US. Bitcoin is deemed by people to be less green. We know that narrative is a false narrative. But that is what institutions believe and they struggled to get it passed their boards and their investment committees because of it.
But Ethereum will be much greener. In fact, it's 99% less energy use than Bitcoin once it moves to proof of stake. So, that removes that barrier. And that's a big stumbling block for institutional adoption. But there's something more important, something that most people haven't thought out, which is that Ethereum is going to have a yield of 4% to 6%. That's the best guesses.
So, now we've got the internet bond. And I know people have used that terminology before, but they haven't really joined the dots as what that means. Ethereum being the largest yielding asset in the space, it has a in ETH terms a risk-free rate yield, because it's generated by a smart contract. So, it pays out yield in the smart contract. Now, the risk you're taking is currency risk, ETH. And again, people need to understand what these terms mean, because there's a lot of bullshit online.
So, what you've got is a pretty much a guaranteed yield from ETH. Obviously, there are things that go wrong. US bonds are deemed risk free, but they're not, nothing is in the world. But you know what I mean, this is a benchmark yield for Web3 from largest asset in Web3, because Bitcoin doesn't have a yield in the same way. And it's not really used in web3.