Pet Rock

04 September 2025

Following a consolidation phase over the past few months that technicians would call a bull-flag, spot gold has broken higher in the direction of the primary trend (chart 1). From our perch, the shift in short term interest rate expectations and growing concern over the Fed’s independence and credibility are the most plausible explanations for the impulsive move in spot gold. Recall that gold largely reflects three key fundamental drivers: 1) the real Treasury yield or the value of the competing asset, 2) the inverse of the US dollar (fiat currency), and 3) the price of financial risk (CDS or credit spreads). Stated differently, Gold tends to perform well when the “Federal Reserve is inflationary” especially when the Fed is accommodating irresponsibly loose fiscal policy.

Chart 1

Source: Bloomberg

As we noted recently, the Federal Reserve’s reaction function is often presented as clean and rules based. If the labour market weakens or inflation expectations fall below target, they cut. If both are strong, they hold or hike the funds rate. However, history suggests that the reaction function is more complex. The Fed is not just calibrating inflation and employment; it is managing system fragility. The longer the Fed insists on maintaining policy data dependent, pointing to solid employment or firm inflation surveys, the more it ignores the slow accumulation of stress in credit, funding markets, and trade channels. Stated differently, labour and inflation are lagging indicators. In contrast, fragility is what forces abrupt policy pivots.

Compounding matters in the current episode is the growing concern about the Fed’s independence and credibility. Clearly that is related to public debates about the pace and scale of monetary easing. Any sign of policy errors or wavering autonomy will likely amplify the enthusiasm for gold, reinforce the perception of the precious metal as a hedge against financial risk and the loss of confidence in fiat currency. On a longer time frame there has also been a relationship between the fiscal deficit and spot gold (chart 2). In recent years, especially since 2020 there has arguably been greater accommodation of the fiscal deficit. We would also argue that the deficit has been irresponsibly loose. Put another way, the US has had emergency (depression level) fiscal policy when the economy was operating close to full employment.

Chart 2

Source: Bloomberg

To be fair, as we noted in August, there has been a notable deterioration in the US labour market. Trend employment growth has slowed to 35,000 payrolls over the past three months. That is close to stall speed and comparable to the period leading into 2008. Leading indicators of the labour market such as temporary hires, job openings and confidence surveys also suggest that there is a material slowdown in the labour market. If these trends are confirmed in the August employment report released on Friday, the Federal Reserve will cut the funds rate at the September FOMC. Of course, rate cuts are almost never the bold, pre-emptive acts that policymakers like to frame them as. They are reactive by design or a signal that something beneath the surface has cracked. The Fed doesn’t ease when macro conditions are healthy; it cuts when stress is visible to insiders.

The way we have expressed exposure to gold is via a basket of gold miners (available on request). We added that position back in the first week of August. The sub-portfolio has rallied 25% since the start of August and 75% so far this year. What is extraordinary is that the basket still only trades at 10 times cash flow compared to 15.8 times for the MSCI World Index. Tactically there is near term risk if the US macro data remains resilient preventing a more accommodative stance from the Federal Reserve and a reversal in US dollar weakness and the impulsive nature of the recent move in spot and gold miners. However, the breakout is probably not a head fake, rather it likely reflects genuine sustained demand from emerging country reserve managers and investors more broadly to acquire gold as a hedge against inflationary policy.

20250904_Pet_Rock.pdf

Download PDF • 448KB