Demand for taking delivery of physical gold and silver has multiplied thanks to institutional investors and investment banks ditching their positions in the asset class. As much as an eleven percent falloff in the spot market over the last week and few days have given investors the opportunity to buy in at relatively lower prices. Although the physical market represents merely a fraction of what occurs on the futures exchange, the two markets really do represent a bit of a dichotomy in the preferences of the two types of investors at present. The institutions are net sellers of the gold backed ETF’s and there is absolutely no shortage of buyers for physical. Demand has been so strong that for the individual investor to purchase physical gold and silver right now, the smaller dealers are quite simply limited or sold out, and our customers despite being able to buy at current prices face wait times of four to six weeks to take delivery.

On top of weeklong wait times for delivery, mints are operating at full tilt. According to statistics from the US Mint, they have produced and sold 153,000 one ounce gold eagles in this month so far. They are on track for their biggest month since May of 2010 when they did 190,000 ounces. This influx of buyers to the physical market could be from customers averaging down the cost of their initial investment, but also many are just taking this selloff in the market as an opportunity to buy. Despite the sharpest two day drop in the gold market since the early 1980’s gold and silver have clearly not lost the status of a precious metal. The current market demand reflected in the premiums that investors across the globe are willing to pay validates this; furthermore, it tells a story of an investors desire to hold the metal.

Over the last decade the desire to hold precious metals stemmed from the perceived status of a safe haven for capital. There was usually a flight to the gold backed ETF’s following a sizeable selloff in the equity markets. Following years of accumulating metal positions, the gold backed funds finally starting dumping some of the tonnes of gold they hold for their investors. And although it was quite easy to gain access to the appreciating price of gold by simply buying into one of these funds backed by bullion and futures contracts, it did come with the same level of assurance in actually holding the metal itself. But as that was not the desired interest of the investor, there really was not a widespread interest in acquiring delivery of physical gold.

Demand for the metal aside, there is still no clear explanation for this kind of downward movement in the price. Across any asset class there is always a reason for why the market moves. When the Dow went from above 14,200 to around 6,500 in a matter of months, it was because the US was entering the worst recession since the Great Depression. The fact that institutional investors have lost their interest in the precious metal as its short term outlook wanes does not really justify this kind of collapse. Of course there is the IMF revising down global growth forecasts, which trims demand for commodities, and China’s growth numbers contributed to this just last Monday, but as the volatile gold market illustrated, it’s a market that is based more on perception and less on fundamentals.

The revelation the European central banks, particularly Cyprus, may start selling gold, but only an amount that is less than a tenth of what we’ve seen the ETF’s sell this year contributes to this. And this just helps me reaffirm my view on gold. It’s not a sure thing. It never was. But gold is an asset that throughout time has been thought of as money. And with the Bank of Japan being the last central bank to embark on an overaggressive monetary policy, as fiat money is naturally inflated, I perceive gold to continue to have value. The market may prove me wrong, as in a short term perspective it has done that too many that have bought before this fall, but gold for me gold represents a small hedge in a portfolio with a longer term holding period.

Ahead of Friday’s all so crucial job numbers, the markets seem to have taken a bit of a breath. This rally in the US indices which led to the Dow and S&P to gain 11 and 10 percent respectively in the first quarter amounted to the best start to the year since 1998. Gold, quite simply, has become an unpopular trade when there exists this present opportunity in the US markets, and this is without deference to the fundamental reasons for what is driving them higher.

Societe Generale released a special report this week that’s caught the attention of many commenting on what they dub “The End of the Gold Era.” Further, their bearish outlook has the price of gold to finish the year at $1,375 per ounce. This differs significantly from estimates amongst Bloomberg traders that are looking for $1,750/oz., but what Societe Generale sees coming is the beginning of a long and slow bear market. They are of the extreme, but commodity divisions at some of their fellow investment banks followed suit as they are not alone in forecasting lower gold prices in the two years to come.

Many gold bugs attribute lower prices to the banks suppressing the price of the metal in order to cover positions from a gold carry trade. This conspiracy theory may potentially be valid, but lacks originality as it has been used in the past, and as recently as the UK Treasury announcing in May of 1999 that it would sell half of their gold reserves. The very announcement sent the metal down to $250/oz. The difference, however, was in that short time ago there was still a resurgent US dollar, and no need for an alternate safe haven.

The reign and outlook for the US dollar now though differs significantly from a decade and a half ago. For good reason, in the late nineties, gold had lost its popularity as it did not serve the same role in international finance that it does today. For many of the developing central banks around the world it is the hedge against holding US dollar assets, and that is why central banks opt to hold it in accordance with their US reserves. It is the same reason an individual investor might hold gold; it’s a hedge and not sure thing. Even with Germany as recently as 4 months ago, the country acted to repatriate a portion of their gold—they brought it home, they weren’t selling.

Amidst lower prices for gold bullion, the story has not changed. Japan’s central bank announced this morning that they were to double their monetary base over the next two years in order to spur inflation. The US Federal Reserve has a balance sheet thrice what it was before the latest global recession, and there is no event in economic history that can provide any indication for how they will unwind their holdings. That’s just rationale for diversifying from an inflationary or monetary perspective. With the degree of capital controls not only going into place in Cyprus, but also across the Eurozone as a whole, an investor has to wonder how stable our financial system truly is.

When there is still this level of uncertainty in the global market place, there is still reason to hold a little gold. In the very scheme of things, a positive quarter is great, but the question is can it sustain. For the time being, only a contrarian would say no. But I guess the contrarians were the ones buying gold at $250/oz. in May of 1999 and not selling it.

We have been so preoccupied by the return of the US markets that we have failed to notice how far behind our own TSX truly is. The Toronto Stock Exchange is not accompanied with the same level of optimism that is present in the United States; its current level is not much different than a few years ago, and it is 15 percent below its peak in 2008.

As US markets have been driven by the resurging strength of their private sector, led by their financial institutions, it’s been a diminishing demand for commodities that is largely seeing our market trade lower. And as lower commodity prices have been triggered by a waning global demand, our market has lost the link to that of the US.

As the above graph illustrates, in about September of 2011, two markets that exhibited a relatively higher level of correlation began to diverge. Since then, it was the US indices that have been supported by the initiation of the second round of quantitative easing and stronger corporate balance sheets. By falling vulnerable to the slump in global demand for commodities, it was our mining sector that was particularly impacted. Furthermore, as the junior mining sector struggles not only with the weaker demand, but also less than attractive precious metal prices, the continued outlook seems rather bleak.

Bloomberg put out a piece this week that discussed the slump in the price of the yellow metal and it makes it very clear why stock prices have been discounted with lower prices. In addition to the negative light on the mining sector, there have been record sales from the very ETF’s that allow investor to gather easy exposure to the price of gold. But to do with mining, large mining companies estimate the cost to take an ounce of gold out of the ground is 993 USD. What’s important about that number is that this is the cost for what would be a “blue-chip” company that likely mines both more efficiently and cost effectively. As the junior market struggles and prices hold at these lower levels, their margins will get slimmer and slimmer.

But it’s the respective returns of the two stock markets that exemplify the difference between our two respective economies. The Canadian economy, and more so the Canadian stock market, depend on the health of our natural resource sector. And it’s no surprise that a stall in global economic growth like we saw in the period between 2010 and 2012 has caused our indices to trade sideways and not present a positive outlook.

The challenge, though, is trying to determine what lies ahead. The United States sits with a monumental opportunity thanks to their abundance of oil and gas reserves. This is something that is not only favorable to the US consumer as they likely face lower energy prices, but this abundance of supply keeps downward pressure on global energy markets as well. As the US looks to be self-sufficient in terms of energy, which is a stark difference from a few years prior, Canada’s need to search for alternative trading partners increases. Keystone is important along with crude and gas production currently going to the US, but Canada’s opportunity for growth is elsewhere.

In August of 2011 when Standard and Poor’s downgraded their rating of US government debt, markets were shocked. The downgrade came on a Friday after the market close, and when the US markets opened the following Monday morning, the three indices fell between 5 and 7 percent over the course of the day. What a reaction.

The ultimate safe haven that day was of course the US dollar, which is the ultimate paradox of financial markets, but funds flew into the very US government bonds that had been downgraded three days prior. Over the past week we witnessed both Moody’s downgrade the sovereign debt of Great Britain, and Fitch issuing warning on debt and lack of budget and entitlement reform in the United States. These are two ostensibly apparent issues, yet the equity markets really seemed to shrug these warnings and downgrades off.

Its seems that the markets have finally grasped the idea of “not fighting the Fed” by continuing to move money back into equities and risk assets in lieu of sitting idle in cash or savings. This is despite what might be some investors concerns over the return of their capital verses the return on their capital. The Organization of Economic Cooperation and Development (OECD), however, offer another opinion for reason why we would not expect a market reaction. They suggest the rating agencies have a “poor track record of sovereign risk pricing over the past twenty years;” furthermore, “any downgrades should be carefully scrutinized, and not taken at face value.” There is plenty of evidence to back up this claim, but the fact that the rating agencies often are late to the party (or in some instances completely miss it) doesn’t mean there is no concern for the alarming debt levels in the worlds advanced economies. Moreover, it is often the case with the complexity of these issues pertaining to sovereign debt, there lies more to the equation than we see.

Latest estimates for the United Kingdom’s Debt-to-GDP ratio are for roughly 81 percent. Though that ratio is much higher as we look across the peripheral Eurozone or perhaps Japan, it is not the ratio itself that worry’s analysts, but the UK’s ability to reign in their debt burden over the next few years. Particular to the UK, and also as an aside is the massive threat their financial sector continues to pose as some estimates have their liabilities at 2.19 times the country’s GDP.

Ultimately though, this has become ‘the debate’ in economics with respect to a nation’s macro economy and what importance should be associated with their debt load. More liberal economists don’t see this number as particularly important because when a country faces recession or slow growth, there are more concerning issues with long term unemployment and workers losing the skills to advance in the work force and develop the economy. The other side to that coin is that by monetizing or inflating a country’s debt only acts to discourage saving and creates a burden for the rest of the economy by only delaying an inevitable problem.

One thing is clear that continuing to finance government expenditures by running continued deficits limits the reach of government and exhausts their ability to successfully stimulate the economy when the next shock hits. We literally have a conundrum with countries like Great Britain or the US because austerity measures need to be imposed to bring balance back to their budgets; however, these draconian cuts have serious consequences for economic growth in the near term, and as witnessed daily, they are both socially and politically unpalatable.

Without manageable debt levels, a central government’s ability to react and respond to crisis is hindered by its over-encumbered promises of the past. Regardless of debt rating agencies raising the red flag, this is an ongoing problem with no clear solution in site.

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The G20, a group composed of finance department officials and central bankers from twenty developed and emerging market economies from around the world are meeting this weekend in Moscow. One of the main topics of discussion will be the notion of currency wars and the links to fiscal and monetary policy. This whole premise of currency wars though has sparked a fear amongst investors that there will be a period of extreme volatility in exchange rates. Quickly though, the word “war” is far too extreme. It perhaps overhypes the implications of these policies. None the less, measures to spur domestic growth do have direct implications on a country’s exchange rate, and thus are much more far-reaching.

It was earlier this week, when a subgroup of the G20 (known to as the G7) issued a statement that created much confusion and unnecessary conflict around currency devaluation. To summarize, they proclaimed that central banks are permitted to utilize domestic policy measures to stimulate economic growth at home. In essence, they are saying that it is simply okay for policy makers to be willfully blind and not consider the unintended consequences of domestic policy on their exchange rate with nations with whom they trade.

It’s my opinion that the G7’s statement is truly naïve and lacks depth. There is no question that central bankers enacted these policies to spur domestic economic growth. The off shoot, however, is that these policies often devalue their price level and in turn their currency which encourages export led growth. The reason being that when, for example, the US dollar depreciates against the Chinese Yuan, US goods can become cheaper in China as fewer Yuan are required for the purchase. So really, it depends in which context a policy is considered domestic in a global economy.

Japan, for somewhat good reason, has been scapegoated as the villain when it comes to the excessive policy of central banks, but unfortunately for them it is because onlookers have a very myopic view. Furthermore, it is a faux pas for a Prime Minister to intervene in the actions of his central bank and thus has directed a lot of negative attention. That being noted, Japan’s currency has appreciated significantly since the financial crises because the country attracted capital as a result of the lose policy from the US Fed as investors seek a safe haven. They are only attempting to restore balance in their export led economy which has been competing with a strengthening Yen and loss in productivity from an aging population.

None of the above is to act as a defense for the Bank of Japan or the policy actions of other central banks around the world. It is simply fact. Many central bankers are following the actions of US Federal Reserve and the Bank of England such that their currency is not viewed as a safe harbor to attract capital and cut them off from export markets. This is why we have seen countries like Egypt and Brazil be considered as losers because they are or perhaps were strong emerging economies that attracted capital; therefore, their respective currencies appreciated against the US dollar.

These policies, prompted by central banks are primarily intended to encourage investors to put their money back into the economy and invest in equities and businesses. It is to prompt the reinvestment of cash that has been sitting idle for the last four years. What’s unfortunate is that there has to be a cost for all this beyond the notion of currency wars. The US Federal Reserve simply cannot triple their balance sheet to finance the US Treasury’s (aka Federal Government’s) operations without a cost. Same with the Bank of Japan who will tolerate higher levels of inflation by increasing bond purchases financed by expanding their money supply to encourage economic growth. Many are predicting inflation, it could be a credit crunch, it could be an erosion of confidence in the markets, but there’s no such thing as a free lunch.