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There is a bizarre dichotomy between financial markets and the economy. According to Gillian Tett of the Financial Times, this stage of a global economic recovery would normally be associated with much more volatile stock markets as interest rates rise and there breeds a divergence of investor opinions on growth expectations. Instead lackluster economic growth reported for the first quarter in both Canada and the US are paired with muted market reactions and record low measures of both volatility and forecasted volatility in the days ahead.

This really is the first time investors have had to grapple with the question surrounding what role policy makers play in the financial markets. The shift between public to the private has many questioning whether the underlying economy on its own can assume this role. And naturally, this should be a point where the economy is reaching escape velocity (to borrow the words of superstar Bank of England, and former Bank of Canada Governor Mark Carney). Instead though, we are at a crossroads.

The sovereign bond market is telling a much different story than what is going on in the equity arena. While the S&P500 continued to make record highs through the final trading week in May, the US 10 year Treasury bond is sitting on its lowest yield in a year. Some analysts attribute this to the potential for credit easing in Europe pending future actions from the ECB Thursday of next week. Potentially, forward looking yield hungry investors are shifting across the Atlantic. But an additional scenario, again from the Financial Times this past week suggests China’s appetite for US debt is once again growing, having just recently peaked in November of last year. And with gold being the natural hedge to the US dollar, growing demand for Treasuries should be accompanied by stronger demand for the yellow metal from China.

Demand from Asia will always create a natural support for the price of gold. But given that growth in demand from China has been almost exponential, it’s hard to envision this will be the catalyst that sees the price of gold surge in the months and years ahead, accounting for the negative price action beginning in September of 2011. The price of gold, however, has two strong natural drivers, and they are inflation expectations and economic uncertainty. Economic uncertainty is almost an ex post or after the fact type of idea; it ads momentum to the market. Despite every doom and gloom analyst repeatedly trying to predict the next great recession since 2008, these past six years have illustrated their lack of skill in forecasting. Black Swans are a lot more apparent in hindsight.

It is inflation expectations, preceding actual future inflation that will sustain a rally in the price of gold. This did not occur immediately following the US Federal Reserve expanding their balance sheet. Inflation expectations were high; inflation did not ensue. One reason was the velocity of the money supply remains at record lows as money is not changing hands. With an uptick in the economy, which by expectations could come in the second quarter, and the velocity of money increasing, this could lead to inflation and will begin the renewal of the bull market in gold.

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We will be at the Canadian Investor Conference this Sunday and Monday (June 1-2, 2014). We encourage you to come out and see us, and enjoy the event. Details can be found at Cambridge House’s website (Click here).

 

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2014 so far hasn’t really panned out as many had anticipated. While financial markets, particularly equities have seen the volatility that many analysts called for, the year of a strong greenback (US dollar) corresponding to a strong US economy is yet to develop. For this reason it is interesting to think back to some of the more high profile forecasts for 2014, and then weigh them with how the economy has fared thus far.

The key themes for Canada in 2014 were that the Canadian dollar was going to continue to decline and settle in the mid to high 80 cent range. While the dollar tested 4 year lows, the story lately has actually been of the apparent strength and resilience of the Canadian dollar.

Along with the loonie, commodities were certainly not in favour in the beginning of this year following many of the world’s natural resources entering bear market territory in 2013. And despite the story of extreme slack in the global commodity markets from waning demand and excess supply, it has actually been the rebound in energy and precious metal prices that has the TSX up close to 9 per cent year to date.

Even though it was the natural resource theme that carried this country through the global recession that began six years prior, growth in the economy will begin to be more broad based as the year progresses. There is no doubt though that natural resources will remain centerfold to Canada’s economy. Moreover, when it is accompanied with government policy that promotes growth in international commerce, Canada is really then set to prosper.

The most welcomed government policies have been the free trade pacts and agreements going into place with South Korea, the Eurozone, and the current negotiations involving 11 nations in the Trans Pacific Partnership. This is where the focus of Canadian business should lie in promoting relationships that see more of our goods and services offered outside this country. Removing barriers to increase the size of a marketplace in which we can compete gives us this opportunity.

Needless to say, this doesn’t omit that we remained challenged with some structural problems here at home. Bank of Montreal Chief Economist Douglas Porter estimates that for the 12 years spanning 2002 to the end of 2013, unit labour costs in Canada rose 98 percent verses a mere 10 percent gain in the United States. As Canadian labour costs increased significantly relative to the States, breaking down Canada’s gains reveals 28 per cent was attributed to weaker productivity versus 70 per cent being due to a strengthening loonie. As a strengthening dollar no doubt held back Canadian manufacturers, examples like the Canadian auto industry seeing zero new investment dollars in 2013 serve sobering reminders of where innovation is needed, especially when the fate of a currency is subject to market forces.

And with the dollar, Bank of Canada policy becomes an important factor. Like the US Federal Reserve though, as the economy gains strength and more stability, monetary policy will play a much smaller role with central bankers returning to the shadows. It is simply our central banks wish to see our economy return to normality, and with that the active role they have played will slowly subside. And as the US economy rebounds, the forecasts for a weaker loonie and stronger growth on the back of our neighbours to the south will ensue.