As Canadians, we cannot help but shiver a little bit when Stanley Druckenmiller, the man that “broke the bank of England,” with George Soros, calls for an end to the commodities supercycle. In doing so he also added to this call by suggesting shorting the Australian dollar. A bold prediction for a country that hasn’t had a real recession since beginning of the 1990’s, but if the tides are turning for a natural resource and export based economy like Australia, then one could only fathom what the implications could be for us here in Canada.

It’s no secret that the TSX is one of the worst performing global indices since the beginning of this year. That largely can be attributed to the decline in the price of commodities, but if that’s paired with the slump in demand for natural resources—the slide continues. So as the bears come out for the Aussie dollar, the ones for the Canadian dollar follow. Just this week TD revised their forecast for a 90 cent loonie for the fourth quarter of this year. And despite the stability of our economy, and the fact we resembled what might be the least dirty shirt in a laundry basket, the tides have definitely turned in the global outlook.

The focus right now is continuing to surround the United States and their equity markets. “Smart money,” labeled after the endowment funds for a lot of the major American Universities like Stanford, Princeton, and Yale are reported to have dumped their exposure to US debt. Three years ago would have been a different story when approximately 30 percent of those particular funds exposure would have been to US treasuries; that allocation is no around 5 percent. The bull run in the bond market thanks to the US Fed has definitely served them well, but the looming threat of inflation risk in bonds is getting more and more prevalent, which causes these funds to reach for yield elsewhere.

It’s not inflation risk, however, that is the fear of the US Federal Reserve Chairman Ben Bernanke. When speaking Friday at a lunch in Chicago he addressed the potential danger of asset bubbles. The chairman hinted at reckless speculation triggered from low interest rates and there is no question that has been the concern of many bond market vigilantes since the onset of this quantitative easing program. But as the Bank of Japan has made clear following the actions of the US Fed, it’s not in an investor’s best interest to bet against a central bank. As the Japanese yen surpassed 100 yen to the US dollar earlier this week, Japanese investors are even fleeing their own currency.

As the FT says, Abenomics is kicking in, and for the first time since the BoJ’s ultra-loose monetary policy change Japanese investors became net buyers of foreign debt. They are opting for dollar or euro denominated bonds in lieu of their own. Simply stated, a depreciating currency onset by inflationary policies is a tax on savings. That said, we are definitely in the middle of a shift in the global market place, and whether it’s a secular bear in a long term bull market for commodities, or central banks really are our savors, the tides have turned.

If anything is evident from the United States first quarter GDP numbers it is that confidence has returned to their economy. Consumer spending, which contributes to approximately two thirds of their gross domestic product, surged to its highest level in the past two years. This is despite not only consumers facing a smaller paycheck as median incomes shrank in the quarter, but also as Americans saw their savings deteriorate as this increase in consumption was fed by a rising debt burden.

The question from here though becomes what is the outlook for the rest of this year and going forward for the US. Really, it can go one of two ways. One being that increased confidence provides the private sector with the motivation it needs to take over from what has been an overbearing public spending spree. Another is that growth subdues once again as individuals face the constraint of their smaller budgets. As consumption was by far the greatest contributor to growth in the quarter, the hindrance came from government spending as the greatest cuts imposed since the Korean War acted like an anchor on the economy.

The untargeted government spending cuts prompted by budget sequestration has hopefully now been realized to be of no benefit. And I stress this is for the reason of the mere fact that these cuts were untargeted and only ever presented as a scare tactic and not actual debated and well thought out policy. What the most recent events, however, have revealed is that the politics of this whole charade became even clearer. For example, the mandatory furloughs for air traffic controllers were a major spending cut in the department of the FAA, yet there existed greater inefficiencies. And due to their impact on the average taxpayer, congress quickly acted to reverse this decision in attempt to preserve what little popularity they might still have.

Back at the end of March when sequestration was implemented analysts discussed the negative connotations of these draconian spending cuts implemented in an inefficient manner, but seeing them now materialize gives an indication of what more is to come unless restructured. When an economy enters a recession we do see an increase in government spending as it attempts support the shortfalls from the free market system. I am not presenting this to act as a proponent of Keynesian economics, but merely looking back at history as evidence. As the growth engine revs up once again, there in theory should be a handoff from public to private. Of course, the ongoing problem is that this handoff is all but seamless.

Allowing a few weeks to let these lower precious metal prices settle in, it’s interesting to understand the mindset of a gold or silver investor. This is because they buy gold at these levels the same as they did at 1,600 or 1,700 per ounce. The story has not changed. We live in a time period where populism and idealism trumps realism and that is what guides our political system. These shortfalls of a central government are compensated for by central bankers whom have been forced to rewrite economic textbooks in order to avoid sending our livelihoods into ruins and only hope for no catastrophic consequences. With that in my mind, let’s hope people can stay this optimistic about the economy to keep spending and growth advancing.

There is a lot to make of the action in the gold market over the last week as the precious metal touched on its lowest level since July of 2011. Over the course of the day on Friday, the asset that over the last few years had been perceived as a safe haven for capital in an unguided global economy lost over 4 percent (or almost 80 dollars an ounce). Furthermore, there was sustained selling throughout the day as no bottom has seemed yet to appear. This selloff though, can really be attributed to three main events over the past week, and the rationale behind them will continue to influence the market in the months to come.

The first is based on the sentiment of investment banks and institutional investors. It seems for many, after this decade long run it might be time to take a profit, and this increased coordinated selling definitely puts downward pressure on prices, especially for investors that follow the herd. Too many analysts are calling this the end of the commodities super cycle, and although there is a remote chance it could be, this helps to explain why we are seeing a selloff in gold that is also linked to other commodities like oil and cooper. But as Goldman Sachs seemed to be inspired by the bearish initiative of Societe Generale the week prior, earlier this week they followed suit by presenting a bearish case for gold themselves that had many analysts attributing this as the catalyst for the further move downward. For a bank that had the reputation for being advertently bullish on the metal, this came as a bit of a surprise.

The second contributing factor to the selloff in the gold market this week was Cyprus announcing the potential sale of a portion of their holdings. And well this small crisis hit country would in the scheme of things not have that great of an impact on price as they bring bullion to the market, it is the revelation that the Euro crises is far from over. Furthermore, it’s not just the Central Bank of Cyprus that could sell their gold holdings to turn profits from the sale over to their respective governments; it’s the fear that the likes of Portugal, Spain, and Italy might do the same.

Also in Europe, there will be elections in Germany where there lays the risk of the tolerant Angela Merkel being turfed from office. And although the Germans have become associated with the painful austerity themed budgets across bailed out EU nations, any successor to Chancellor Merkel can be seen as a potential end for the Euro. And this is as the common German fails to recognize they’ve been beneficiaries of a weak exchange rate, but more importantly from their perspective they’re the purse for irresponsible neighbor countries. Over the last few years though, as gold has benefited from a risk on trade with the Euro, weakness in Europe would not be good for gold.

The third and perhaps paramount event stays with the most important central bank in the world. The Fed released minutes from their most recent FOMC meeting where a continued number of district bank presidents look to reign in or end asset purchases by the end of this year, and one believes even as early as this summer. Putting aside the unanswered questions of rising long term interest rates and the impact that has on their balance sheet or for that matter the interest payments from the US Treasury, the Fed’s job is to be bias. It is within their role to convince market participants that we are well into a recovery so that consumption and investment levels are restored and firms will continue to hire. To make one bullish prediction, gold’s next big move will be when QEIII doesn’t end in the manner many are hoping for.

The Comex has had net long positions in gold for more than a decade; they are starting to decrease. I’ve talked about the role gold plays in a central banks Forex reserves to diversify against the dollar, but as Cyprus just recently reminded us, it serves a role in crises as well. The most recent FOMC minutes showed the US Fed sees continued hiring and moderate improvement in the US economy. Put those three together and it’s a fairly ugly week for gold.

Perhaps being rational is not a goal of the European Central Bank or the International Monetary Fund, but it seems providing Cyprus with an ultimatum to generate their share of a bailout for their financial sector within four days’ time would not be the optimal strategy. These were the same officials, however, that thought it was a good idea to instigate the panic that created the possibility of a bank run. Thank goodness Cyprus enforced a bank holiday for the last week, because if it was not the lack of liquidity that would of caused their banks to fail, the policy makers would have accomplished this in the form of a bank run through their initiatives.

As of last Sunday, not since the lessons learned from the Great Depression and the utilization of a scheme known as deposit insurance has the idea of a bank run ever even been so credible. Quite simply, a banking crisis stems from the issues of solvency and liquidity. When a bank does not have sufficient assets to cover their liabilities, they run into the issue of solvency. When they have trouble borrowing to satisfy their short term liabilities, there is the issue of liquidity. As of late, the ECB has been providing Cypriot banks with Emergency Lending Assistance (ELA) in order to ensure the liquidity of their financial institutions, and they threaten to halt this lending next Monday. It is important to decipher though between solvency and liquidity, as central banks only aim to assist in the latter. It is not their intended mission to float insolvent banks, but they are walking a fine line with Cyprus.

And it’s their troubled banks that last summer put Cyprus in a similar situation to Greece, Ireland, Spain, and Portugal. The lack of liquidity in their financial system required the Cypriot’s to request a bailout. There is a stark difference between the little European Nation that contributes a mere 0.2% of total Eurozone output to prior rescued nations, and that is with regards to whom their debtors are.

The fact that the majority of the large depositors are Russians and not predominantly other Eurozone nations somewhat alleviates the fear of contagion. Not to come across as overly simplistic, but the escalation of the Euro crises a few years prior was due to the fact that member nations held one another’s debt. Once the first domino fell, contagion quickly spread. That same fear is not as apparent with the situation in Cyprus.

Maybe Cyprus could very well be the first nation to leave the Euro currency, but unlike the rash deadline imposed by the IMF and ECB, this event will not unfold quickly. The total public and private external debt, meaning from lenders outside of Cyprus is approximately five times the country’s GDP. And half of that debt is short term deposits, hence why this situation is serious, yet will not unfold quickly. Banks may reopen as early as next week, but that is unlikely. What is likely is accounts will be frozen; depositors will have limited access to their money. If they did have access, they would withdraw their funds only to exacerbate the problem.

The question with Cyprus is no longer if and when they default, but how they default. This is nothing short of a very unfortunate situation for the citizens of this tiny Mediterranean country; however, if there is not some willingness of collective compromise no one gets their money back. Rest assured, there will be compromise because it will be forced. Two initiatives will have to remain in place. One we heard yesterday; the Cypriot Central Bank guaranteed deposit insurance would remain intact on accounts less than €100,000. This will hopefully provide the foundation to prevent a bank panic. The second is that some sort of haircut is taken on deposits or other form of sacrifice takes place. For example it might be in the form a deposit being converted into a long term bond.

There can be rallies in the street and turmoil surrounding government buildings, but plain and simple, when the numbers don’t add up the options are extremely limited.

Investors have not been this optimistic about the global economy since the financial crises. And as of late, there have been a consistent number of positive economic reports that have continued to contribute to this rally in the equity markets. With the yield on US 10 year bonds back up over 2 percent today, it is evident that a risk on play is continuing to develop in the markets. And as safe haven sovereign debt sells off, metals have benefited from this trade.

I think it’s in my blood to be a skeptic, and that side of me will overcome the joyousness shortly, but it is important to start with the positives in this market right now. Despite the rejigging of corporate balance sheets and the profits that prevailed from businesses vastly cutting costs, the US private sector looks to be optimistic about the economy, and for that reason they are hiring. The job numbers released this morning (which are looked upon with caution because of their volatility) are for the first time since the financial crises one level above mediocrity. Given the US labor market requires growth of anywhere between 90 to 120 thousand jobs a month to keep up with population growth, seeing payrolls add over 220 thousand positions is very positive and hopeful for economic growth.

It is also the hope and optimism of investors that has continued to fuel this rally in the stock markets. The Dow Jones Industrial Average took out its previous high set in October of 2007, and came back from the low of below 6,500 in March of 2009. There were many pundits who did not seem to care because of the Dow being an outdated and undiversified index, and in a sense they are all correct, but the real reason it is attracting this much attention is because the valid S&P 500 will shortly tell a similar story.

There is no question these markets have come back from some very dark days, and right now it’s hard to argue that equities are not the place to be, but there is more than the optimism of investors that is carrying this market. Since its bottom in March of 2009, equities have been lifted by the operations of the US Federal Reserve as they ensured liquidity in the US financial markets. It was the fact the Fed could act as a back stop for creditors, and guaranteed to borrowers that interest rates would not skyrocket that there is this level of optimism in the market. Referring to the graph, the highlighted time periods represents purchases of treasury bonds and Asset Backed Securities by the US Federal Reserve and the actions of their efforts is quite clearly evident.

With this much optimism in the markets it does not take too much time for the typical economists or analysts of other views to raise warning flags. Nouriel Roubini, the economist known for calling the housing market collapse believes the crash from this bubble in this bond market will be greater than the previous crash of financial markets in 2008-09. There is no question as to whether or not there is a bubble in the bond market, especially when you have the world’s most powerful central bank suppressing interest rates and holding up prices. The question is instead, what’s there exit plan?

US stock markets have come back from the lows of 2009 and that is great. And broadly speaking, US stocks do represent the opportunity in this market at the moment. But instead of trying to make my case myself, I’ll quote former Citi CEO Chuck Prince.

“When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.” That was in July of 2007. Refer to the graph above to see what happened next.