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Podcasts from Confluence Investment Management LLC, featuring the periodic Confluence of Ideas series, as well as two bi-weekly series: the Asset Allocation Bi-Weekly and the Bi-Weekly Geopolitical Report (new episodes posted on alternating Mondays).
Welcome to the Confluence Investment Management biweekly asset allocation report for 10/20/2025. I'm Phil Adler. The surging price of gold and rising stock indices seems to be an unlikely pairing. Confluence associate market strategist and certified business economist Thomas Wash joins us today to discuss why this might constitute a pivot point for the markets and for investors. Thomas, the title of this week's report is the debasement hedge, a tale of two safeties.
Phil Adler:I've heard the term debasement quite a lot recently. Just to be clear, what do you mean by debasement?
Thomas Wash:Well, thank you for having me, Phil. Debasement is the deliberate covert strategy by a government to reduce the real value of its national debt by engineering or tolerating high inflation. This isn't just common inflation. It's a policy choice. Historically, it was literally like clipping metal from a coin.
Thomas Wash:Today, it's executed through expansionary monetary policy like high value money printing or quantitative easing, which systematically reduces the purchasing power of the currency, allowing the nominal fixed debt to shrink relative to the economy's output.
Phil Adler:Well, a policy resulting in high inflation, that doesn't seem to be good news for fixed income investors. You make the point in your report that government bonds are out of favor for several major reasons. What role does government debt play?
Thomas Wash:Government debt is now seen as carrying three major systemic risks, prompting a flight to alternative assets. Well first, there's severe skepticism regarding fiscal discipline and a commitment to long term debt sustainability. Second, central banks are signaling a higher tolerance for elevated sustained inflation which directly diminishes the real value of the bond principle. And finally, the weaponization of the US dollar for geopolitical ends has driven global investors and sovereign wealth funds to seek a non fiat, non political store of value.
Phil Adler:We know, Thomas, the need to service rising government debt should require higher interest payments in order to attract demand. As you said in your report, this causes not only inflation but entrenched inflation. What's the difference?
Thomas Wash:I think the difference lies in investor confidence in the central bank's mandate. Investor skepticism stems from banks like the Fed and the Bank of England signaling rate cuts before inflation is clearly resolved, and the Bank of Japan remaining dovish despite price levels exceeding targets. These actions suggest a tolerance for a problem that is stickier or more persistent than in the pre pandemic environment. As a result, market participants are demanding higher term and inflation risk compensation, forcing higher yields on longer dated securities to protect their real capital.
Phil Adler:Now are we currently experiencing the full effect of entrenched inflation?
Thomas Wash:Well, no. At least not in the long end of the bond market. Governments have been strategically alleviating supply demand pressures by shortening the duration of their bond issuance. This tactic reduces upward pressure on longer duration bond yields, effectively masking the full extent of the entrenched inflation concern that would otherwise drive long term interest rates much higher.
Phil Adler:Besides debt and inflation, you also have cited the weaponization of the US dollar as a reason for the move away from the traditional fixed income safety hedge. I must say that Confluence Investment Management has consistently alerted investors to this event. But for the sake of our discussion today, where did this weaponization begin, and how has it evolved?
Thomas Wash:Well, I I think it's been happening for a while, but the systemic fear truly escalated dramatically with the sanctions against Russia, specifically the severing of major banks from SWIFT and the freezing of foreign reserves. This move was the pivotal event that demonstrated The US and its allies absolute power over international finance. It served as a powerful geopolitical risk signal especially to emerging markets who are now proactively derisking their external balances and accumulating gold reserves as a neutral sanction proof asset to shield their financial sovereignty.
Phil Adler:So basically, instead of buying US Treasuries, foreign governments have been trying to reduce their reliance on the dollar by accumulating gold. How fast has this been happening?
Thomas Wash:Well, yes. I I do think that this has a lot to do with central bank policy, not only just government. But to put it in perspective, for the first time in nearly thirty years, foreign central banks now hold more gold than US Treasuries. China has been a leader boosting its gold reserves by about 20% while reducing its holdings of US Treasuries. But they are not alone.
Thomas Wash:Countries like Turkey and India have also been massive buyers. This isn't a minor adjustment. It's a historic structural shift in the global reserve system.
Phil Adler:And doesn't the very rush for gold itself create even more pressure on on government debt and the dollar?
Thomas Wash:You bring up a good point. Yes. The rush for gold has undeniably diverted some global demand away from the dollar and dollar denominated assets. However, international capital seeking US economic exposure is simply bypassing the debt market and flowing directly into the stock market. This means equities, particularly highly liquid, large cap tech, remains the preferred vehicle for accessing American growth even as dollar diversification efforts accelerate.
Phil Adler:So, basically, Thomas, investors, including certainly foreign central banks, no longer see government debt, and in particular US government debt, as a safe haven?
Thomas Wash:Well, I would say its status as the primary unquestioned safe haven has been at least somewhat damaged. We still see flights to quality into treasuries during crises, but the moves are more muted than before. The proof is in the price. Despite recession fears and rate cuts, treasury yields have remained stubbornly high compared to past cycles. This tells us the bid for duration isn't as strong as it used to be because confidence has been fractured.
Phil Adler:That may be a main reason for the rise in gold prices, but it doesn't explain the relative performance of stocks, which seem to be more or less keeping pace with gold. This is the other safety you refer to in the title of this week's report. How do you explain the performance of equities?
Thomas Wash:Well, think we view large cap growth equities, particularly those driving the AI boom as having adopted a growth safe haven status. Investors are prioritizing these companies for their defensive qualities, robust balance sheets, consistent cash flow generation, and strong pricing power. The rapid rebound in the Magnificent Seven after the market shocks demonstrated this is a strategic move to secure both stability and exposure to secular growth in one highly liquid asset class.
Phil Adler:Well, if investors now view certain equities as value and safety plays despite rising valuations, can we expect more lenient reactions to declining profit margins for these companies going forward?
Thomas Wash:So I would say that leniency will be highly conditional as tech's appeal is rooted in future high earnings. Investors are willing to forgive short term margins and free cash flow squeeze because they view the massive AI driven capital expenditures as a necessary investment for a generational technological shift. Now this tolerance hinges entirely on whether these companies can continuously meet or beat revenue targets and solidify a long term defensible market leadership position.
Phil Adler:Summing up, Thomas, you described these trends in your report as a crisis of confidence in the traditional financial order as central banks recalculate risk. In other words, are we seeing basically a long term reassessment of safety that individual investors should buy into?
Thomas Wash:I would say so. We are witnessing a long term reassessment of safety, a true crisis of confidence in the traditional financial order. You know, capital is bifurcating. Investors are using AI linked large cap tech as a new form of high quality growth oriented capital preservation and gold as the ultimate sanction proof structural hedge against unprecedented US fiscal and geopolitical strain. This dual safety paradigm is a trend individual investors should integrate into their long term asset allocation.
Phil Adler:Does confluence currently have target prices for gold and the S and P 500 index?
Thomas Wash:I would say that we we frame our targets dynamically rather than as a fixed number. For the S and P 500, our models have been consistently positive. While we've exceeded our initial 2025 base case, our analysis still points to further upsides contingent on earnings delivery from the AI theme. Now regarding gold, our conviction in a structural rally is very high. For gold, we see a powerful structural bull market underway and believe a move toward 4,500 to the 5,000 range within the next twenty four to thirty six months is a plausible scenario driven by persistent central bank demand and debasement concerns.
Phil Adler:Thank you, Thomas. The title of this week's report is the debasement hedge, a tale of two safeties. And you can find a link to the written report on the Confluence webpage, confluenceinvestment.com. Our discussion today is based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice.
Phil Adler:This information does not constitute a solicitation or an offer to buy or sell any security. Our audio engineer is Dane Stole. I'm Phil Adler.