Winter Is Coming: What The IMF Just Told Investors

On Tuesday at Semaphore's next 3 billion event in New York, Kristalina Gorgieva said that winter is coming. The managing director of the International Monetary Fund was not talking about gold, she was talking about prices and about what happens to an economy that has spent seven months absorbing an energy shock. Her argument ran roughly as follows. The world has coped with oil at over $100 a barrel considerably better than most people expected, and that coping should not be mistaken for immunity. The Iran war and the energy disruption accompanying it have pushed inflation higher across the world since February. Central banks have responded by raising interest rates, and those higher rates have raised government's own borrowing costs, which then leaves them with less capacity to cushion the damage when it arrives. Now, on her remarks, she pointed out that the United States will spend more this year servicing its national debt than it spends on its own military. Now, artificial intelligence has done a great deal of work offsetting the shock, but not enough to make up for the closure of the Strait of Hormuz. And she also expects the social consequences to become visible, telling the audience to prepare for people to be a good deal angrier, possibly out on the streets. And all of this is pretty useful framing for anyone who's thinking about gold, and you have to consider that it comes from an institution with no particular interest in taking the metal or talking the metal up any higher. What she's actually describing here, what Gorgieva laid out, is a stagflationary risk with a difficult trade-off at its heart. A large part of the inflation pressure is coming from supply. Hormuz has been largely shut since the spring, and in March, the IEA described the war-related disruption as the largest in the history of the oil market. The Saudi east-west pipeline went offline on the 11th September, and according to Reuters, it restarted at reduced capacity on Tuesday, with full restoration potentially taking several weeks. Now, of course, supply is not the only source of inflation pressure, though, and the American economy isn't looking especially weak in the official data. The Fed's own September statement described solid growth and resilient consumer spending and robust investment. And Wednesday's flash composite PMI rose to 58.4, which points to activity accelerating even as costs rise. Now, energy disruption is adding to inflation now while threatening growth later, and the economy, for the moment, is holding up. The trade-off sits in what monetary policy can do and what it cannot do. The Federal Reserve raised rates on the 16th September, a quarter point approved, 12 to nil, taking the target range to three and three quarters to four percent. And 16 of the 18 participants submitting projections judged a higher year-end rate to be appropriate policy. And those are conditional judgments rather than commitments. As we have said many times, a central bank cannot repair a pipeline. It can influence demand to some extent, it can anchor inflation expectations, and it can limit how far energy costs feed into wages and broader prices, which is a real function, it's not some trivial thing. But it does that by slowing economies that are already absorbing higher fuel and food costs and by raising the cost of government borrowing that would otherwise soften the blow. And these are the difficulties that Gorgieva is pointing at. And it doesn't go away just because the growth data this week looks good. So why is gold down? It's just the obvious question. Gold rose roughly 13 percent through August to finish the month at around 4,563. It's fallen since, fell again this week as hawkish commentary from Alberto Muzalam, Austin Goolsby, Susan Collins, Neil Kashkari, they all pushed market expectations of further tightening higher. It is now trading around 4,260 this morning, roughly seven percent below where it ended in August. But why gold's down isn't a big mystery. Gold pays no income, so when the expected path of interest rates moves up, the cost of holding it moves up too. Real yields are at multi-year highs and the dollar has strengthened. What you have to draw your attention to is the scale of the decline rather than its direction. In January, markets expected the Federal Reserve to cut. Nine months later, it has raised instead. And further tightening is widely expected. Real yields have risen substantially and the dollar is firmer. Against all of that, gold has given back a single-digit percentage from a strong August. Gold has nevertheless fallen substantially from its January's peak, so its recent resilience shouldn't obscure the size of the correction investors have already experienced. The relationship between oil and gold is also less clean than everyone's thinking about. Brent settled near $100 on Monday. It fell towards $97 on Tuesday as the pipeline restart came back through. It was back above $101 by Wednesday, and now it's over $105 this morning. Gold has drifted lower throughout. Now, if energy prices do come back down, and I would be reluctant to assume that while Hormuz remains contested, the effect on gold runs in two directions at once. Lower oil reduces inflation pressure, which over time could reduce the case for further tightening. It also reduces demand for protection against precisely the geopolitical and inflation risks that brought some buyers into gold in the first place. Which of those dominates is genuinely uncertain, but it's why you should not expect to watch this relationship work day by day. Now, Standard Chartered published figures this week that shows gold's three-month negative correlation with two- and five-year real yields has weakened to minus 16% and minus 22% from minus 30% and minus 38% a month earlier. Now, don't read that as a 20-year relationship breaking permanently. But instead, what the recent data suggests is that over this particular window, real yields are explaining less of gold's movement than they have been. And the flows are all telling us a similar story. Gold-backed ETFs took in $18 billion in August, and global holdings reached 4,189 tons. That overturns nothing, since rates are only one influence on gold demand. What it does show is that other motives for owning gold remained active despite elevated bond yields. A physically-backed fund is also a very different proposition from owning allocated segregated bullion outright and is worth treating as such. But on positioning, total COMEX net long positions rose 39% in August to 753 tons. Standard Chartered reported profit-taking ahead of the Fed meeting, whilst also noting that positioning was not overcrowded. Position reductions have contributed to the volatility of the past three weeks. Now, I wouldn't claim that they explain the whole of the decline. Gorgieva's observation about debt service exceeding defense spending is the one that we should probably just come back to, because it points at something that daily price action we've all been talking about is obscuring. The U.S. federal debt crossed $40 trillion for the first time in August, five months after it passed $39 trillion. And the Treasury announced that it would at least double the maximum size of its buyback operations in longer-dated securities, effective on the 9th of September, and described this explicitly as liquidity support. Buybacks of that kind do nothing to reduce the underlying deficit. And that pressure takes time to work through. High yields feed into the interest bill as the new debt is issued and existing debt is refinanced. So the pressure builds as borrowing is refinanced rather than repricing the whole debt stock overnight. And it's perfectly possible to have a genuine fiscal problem without anything that looks like a crisis, all of which shapes how we read long-term Treasury yields. They are currently a headwind for gold. And there's no point that trying to talk around that or pretending otherwise. But what we have to ask is why they are high. If it is because the economy is strong and investors expect good real returns, that's genuinely difficult for gold. But if it's because issuance is enormous and debt is compounding and investors want more compensation to lend to the government for the long term, then the number is the same, but the message is pretty different. At some point in that second case, rising sovereign yields stop representing an attractive alternative to gold and they start representing something closer to the risk that gold is held against. I am not claiming that we're at that point immediately right now. But where does it leave us? Well, winter is coming. It's not a price forecast. It's a description of a risk. And the risk is one of persistent supply-driven inflation pressure. Central banks tightening into it with tools that cannot directly resolve the energy disruption and governments paying more to service their debt as it rolls over and populations becoming less patient. Gold's price weakness over the past month and gold's longer-term role in a portfolio, they're not in conflict. Higher rates weigh on the metal in the short run precisely because they raise the cost of holding it. And those same higher rates are what tighten the fiscal position over time. Both of those things can be true simultaneously. And if you own gold for diversification, for purchasing power over decades and for the simple fact that it's not somebody else's promise, well, the past month's price action doesn't bear very heavily on any of those reasons. Nor should we pretend that the argument is one-sided. If inflation is brought back to target credibly, if energy supply is restored and stays restored, and if the fiscal position improves, some of the current supports for gold would weaken. Those are real possibilities and you should hold them alongside everything else here. So what I would watch for is not a particular price. It's whether gold begins to rise while policy remains tight rather than because investors have decided that cheap money is returning. The first would be consistent with other motives becoming more influential. Though price action on its own could never establish that. The second would only tell us what we already know about interest rates and about opportunity cost. Because the case for gold from here may have less to do with waiting for rates to fall and rather more to do with what higher borrowing costs sustained over time and layered on an energy shock that no rate decision can fix due to the balance sheets of those governments whose promises underpin everything else in your portfolio. And if you want to find out more about the levels of risk that are coming, maybe head for the exits and download our free exit guide today.