In early February, we rhetorically asked "How Do We Trade the Loonie?" and concluded it was best to buy the USD versus the C$. Then, the C$ was at a small premium and since, it has slipped to a discount with the USD fetching above 1.03. This is a large move for two countries closely connected by geography and trade. Can the trend continue?
There were two major reasons we took a bearish stance on the C$. Though Canada is noted as a commodity producer, it also has a established diversified manufacturing sector. The United States, almost 10 times the size of the Canada, has long been the major market for their products. Canadian manufacturing, however, has been handicapped by high labor costs and the currency premium. A three percent discount for the loonie helps, but we doubt that alone will be enough.
During the month since our last Canadian commentary, we have observed a big shift in Canadian currency futures positions at the CME. According to the February 5th COT report, speculators were long 34.2K contracts. The most recent report, compiled through February 26th, shows that specs were short 24.6K.
In addition to shifting positions by almost 60K contracts, the size of the C$ futures market grew smartly. In the CME report of the futures only, open interest shows a market that grew from 142K to 221K on March the 5th. The OI has grown by over 11K contracts in the last two days, and is now larger than the open interest in the euro. The expanding OI tells us that the specs are still selling the C$. Part of the growth in the OI, though, may be price fixing by commercials ahead of expiration before the March contract expires.
Canadian economic numbers recently released have been negative. The 4th quarter GDP was a negative .2%, which resulted in the y/y down to only an 0.8% rate. Today, the important Ivey PMI report was 51.1 less than the estimated 56 and last month's 58.9. Additionally, the Canadian Central Bank reported today they will be keeping the rate unchanged at 1%.
According to the Globe and Mail:
"The Bank of Canada said weak economic growth and muted inflation mean that 'considerable' monetary stimulus 'will likely remain appropriate for a period of time.'"
This sounds to me like the Carney is in favor of a weaker loonie.
The second reason we were bearish on the loonie is that we sensed the desire to hold the so-called "commodity currencies" was waning. Indeed, that did happen, as the commodity specs reduced their combined long contracts in the Canadian, Australian, and New Zealand dollars to 14.8K contracts from 158.1K in the last three weeks.
Canada's biggest export is oil to the U.S. Most of this oil originates in the massive oil sands in northern Alberta. This is heavy oil, which normally trades at a discount to WTI. In recent months, because of the increased oil production in the U.S., and the shortage of transportation to move the oil, this discount has been exceptionally wide, as much as $40/barrel, which reduces Canada's revenue. The boom times in Western Canada, largely because of the energy production, have definitely slowed, resulting in some of the Province's scrambling for money.
Not only is the crude glut in the U.S. hurting Canadian energy exports, but so is the shale natural gas supply. Prior to the shale gas revolution, Canadian natural gas moved into the U.S. Now, there is no longer a market for natural gas in the U.S.
The Canadians hope to alleviate the high transportation costs with the construction of the controversial Keystone pipeline. If all four phases of the pipeline were completed, there would be capacity to ship as much as 1 million barrels of crude. But opposition to the Keystone has become the celebrity cause for the Hollywood and environmental interests. Until now, President Obama has delayed giving his approval to the project. In an editorial this week, The U-T San Diego paper hopes that "the Obama administration decide to side with reason over hysteria. "
There are rumors that Obama will approve the Keystone with conditions designed to appeal to the environmentalist. One of the rumors is that Canada will have to pay an environment tax because of the mining the bitumen, processing, shipping and using the heavy oil, which they say does damage to the earth. Who the Canadians would pay the tax to is not known.
Another potential problem of marketing more energy to the U.S. might, over time, be the change of leaders in Venezuela. Chavez, who nationalized oil production, did not maintain the oil fields, and the production went down from 3.5M barrel/ day to 2.5M. While there may be turmoil initially, the potential exists for expanded production. This is heavy oil, like the Canadian, a competitor for the Alberta oil.
Canada needs a plan to market their energy products that does not include the United States. Sure, the Keystone pipeline would help, but just how much? Further, sending members of the oil business to Houston and Washington, begging for Keystone approval, weakens their position. They would be better off building a pipeline to British Columbia. While they are at it, they should also make plans for a natural gas to LNG conversion plant. There are more buyers in Asia, and they will pay more money for the energy.
It looks like the C$ will lose more to the USD (USDCAD, FXC). The issue here is where do you sell the pair? A dip under 1.03 might be expected, but is 1.0250 too much to expect? Should the USD keep gaining, 1.0450 is a target, and above which there may be some stops. As always, manage your money.