Markets are treating the Iran conflict as a shock, not a structural change

In a wide-ranging conversation on the Money Metals Podcast, host Mike Maharrey sat down with Axel Merk, founder, president, and chief investment officer of Merk Investments, to discuss how investors should interpret the ongoing conflict involving Iran, what is driving gold prices, and why maintaining a disciplined investment process matters more than reacting to headlines. 

Merk also shared his views on government debt, market psychology, and the importance of understanding how markets actually function.

Why Gold hasn't reacted the way many investors expected

The discussion opened with the recent escalation in the Middle East following U.S. military action against Iran. While many investors have viewed the conflict as a major catalyst for precious metals, Merk argued that markets are currently treating the situation as a temporary shock rather than a lasting structural change.

According to Merk, this distinction is critical because it affects how bond markets, inflation expectations, and ultimately gold prices respond. He explained that although bonds have sold off amid fears surrounding the conflict, long-term inflation expectations have remained relatively stable. As a result, real interest rates have moved higher, creating a headwind for gold.

Merk emphasized that gold ultimately competes against the long-term purchasing power of currencies. Because markets still largely believe the Federal Reserve retains the ability to control inflation over time, long-term inflation expectations have not dramatically shifted. That confidence, in turn, has helped support higher real interest rates, which can weigh on gold prices even during periods of geopolitical uncertainty.

He also noted that after briefly decoupling from real interest rates during 2024, gold has recently resumed its traditional relationship with those rates. While some observers have suggested gold may be losing its safe-haven status, Merk argued that current price action is better explained by standard market mechanics than by any fundamental change in gold's role.

Long-term precious metals investors remain buyers

Despite short-term volatility, Merk said one encouraging sign is that long-term precious metals investors continue to exhibit a net buying bias. His firm manages more than $4 billion in precious metals assets, giving him a unique perspective on investor behavior.

According to Merk, the willingness of long-term investors to continue accumulating precious metals supports the view that markets see the Iran conflict as a temporary disruption rather than a transformational geopolitical event. While he stopped short of declaring those investors correct, he believes their actions are consistent with the broader market narrative.

He also pointed out that many investors entered the current environment heavily leveraged after an extended period of optimism. When unexpected shocks occur, leveraged investors often reduce risk quickly, creating additional selling pressure that can temporarily suppress gold prices.

When does a shock become a structural change?

Maharrey asked an important question: At what point does a temporary geopolitical shock evolve into a lasting structural problem for markets? Merk's answer focused on the remarkable adaptability of market systems.

Drawing on examples from energy markets, he explained that markets naturally price in some degree of normalization over time. Whether dealing with oil supply disruptions, interest rate shocks, or geopolitical conflicts, investors generally assume conditions will eventually stabilize.

Even in a scenario where Iran gained greater control over shipping routes or imposed fees on vessels moving through the Strait of Hormuz, Merk argued that global markets would adapt. Producers, consumers, and governments would find alternative solutions through infrastructure investments, transportation changes, or energy diversification.

For Merk, the greater threat comes not from the conflict itself but from policy responses. Historically, governments have often reacted to supply shocks with interventions such as price controls, stimulus spending, or trade restrictions. Those actions can create longer-lasting distortions and potentially transform a temporary disruption into a structural economic problem.

The importance of having an investment process

One of Merk's strongest messages centered on investment discipline. He argued that the most important thing an investor can possess is not a perfect strategy, but a consistent process.

In his view, investors should avoid making dramatic portfolio changes based on individual headlines, market commentary, or even conversations like the one he was having on the podcast. Instead, new information should be used to challenge assumptions, stress-test existing positions, and refine decision-making frameworks.

Merk highlighted an important distinction between professional investors and retail investors. Professionals often describe their actions as "risk management," while retail investors may think of similar behavior as "panic." In reality, both groups frequently reduce exposure when volatility rises and risks exceed their original expectations.

He stressed the value of periodic portfolio rebalancing during good times, noting that investors who fail to rebalance often become overexposed to risk assets. When markets decline sharply, they may find themselves facing losses far larger than they can comfortably tolerate.

A simple test for excessive risk

Merk offered a practical rule of thumb for determining whether an investor is taking too much risk: sleep quality. If market positions are causing anxiety, restlessness, or constant monitoring of prices, the portfolio may be larger or riskier than appropriate.

He also emphasized the importance of controlling personal expenses. Investors who consistently spend less than they earn possess greater flexibility and can generally withstand more market volatility. In uncertain times, he suggested that maintaining healthy personal finances may be one of the most effective forms of risk management available.

Understanding why markets price assets the way they do

Maharrey raised the idea that investors often believe markets are "wrong." Merk agreed that skepticism can be healthy, but he cautioned that investors must understand why markets are behaving the way they are before betting against consensus views.

He encouraged investors to approach markets with humility. While opportunities certainly exist when prices diverge from fundamentals, investors should first assume markets may have valid reasons for their pricing decisions. Only after conducting significant research should they commit capital based on a contrarian view.

Merk also argued that some market segments have become less efficient because of the rise of passive investing. During years of quantitative easing and broadly rising asset prices, active management lost favor. As a result, certain specialized sectors—including mining and precious metals—may offer greater opportunities for investors willing to do the necessary research.

He emphasized that successful investing in niche markets requires understanding details that many participants overlook. As an example, he noted that the commonly quoted gold price represents a London bullion market price for a specific type of gold bar located in London. During periods of market stress, prices for gold in other locations or forms may diverge significantly.

Why debt matters even when markets ignore it

The conversation eventually turned to federal debt and its relationship with interest rates. While many investors focus on central bank policy, Maharrey noted that debt levels often receive less attention.

Merk acknowledged that government debt is critically important but explained that debt levels do not produce simple trading signals. Unlike cash-flow variables that can directly affect markets in the short term, debt tends to influence economic conditions gradually over time.

Referencing economist Friedrich Hayek, Merk noted that excessive government debt can undermine the independence of monetary policy. However, he cautioned that investors have been warning about debt problems for decades. The challenge lies not in identifying the problem but in determining when and how it will influence markets.

Rather than expecting a dramatic financial reset, Merk believes governments and societies typically adapt gradually. Inflation erodes purchasing power, households adjust, labor participation changes, and political pressures evolve. The result is usually a long period of increasing instability rather than a single defining moment of reckoning.

Hayek's “the constitution of liberty” offers timely lessons

When asked what he was reading, Merk highlighted Friedrich Hayek's classic work, The Constitution of Liberty. Although he first read the book roughly a dozen years ago, he said it feels even more relevant today.

One theme that particularly resonated with him is Hayek's argument that liberty requires clear rules and shared societal values. Merk suggested that in an increasingly polarized political environment, Hayek's observations offer valuable insights into the balance between freedom, governance, and social cohesion.