Canadian Dollar Rattled by Shanghai Meltdown, Interventionist Talk

Bullish investors betting on a V-shaped recovery for the global stock markets are convinced the worst of the global economic crisis is over, and furthermore, expect the emerging economic giants - Brazil, China, India, Russia, and Korea (BRICK) to become the locomotives of global growth. With China and India leading the way, the notion of decoupling - emerging markets advancing faster than developed markets - and even pulling the G-7 economies out of recession, is making a comeback.

Global speculators plowed a record $35.5-billion into emerging-market stock funds in the first half of this year, faster than at any other comparable time on record. By contrast, traders withdrew $61-billion from developed stock market funds over the same period. After all, its simple logic to invest in a stock market index with a faster expanding economy, such as China and India, rather than invest in a contracting economy, such as Japan, experiencing its worst downturn since WWII.

Attracted to faster growth, global traders are chasing stocks in emerging markets at higher and higher prices, in a parabolic fashion, which often end-ups in a high stakes game of musical chairs. In Shanghai, the world’s wildest casino, the average Price /Earnings Ratio reached 38-times in July, compared with the MSCI Emerging Markets Index which trades at 18-times earnings, the highest level since late 2007, when the global stock markets peaked, before the big crash. Brazil’s Bovespa index trades at 23.5-times profit, near the highest in five-years.

Emerging markets are more volatile than the G-7 markets, because “hot money” flows from foreign investors are often behind the exaggerated price movements. But when “hot money” decides to make a quick run for the exits, and speculators seek to convert paper profits into cash, the corrections on the downside can be violent. Total returns are also impacted by currency fluctuations, often moving in the same direction, due to simultaneous unwinding of leveraged carry trades.

According to IMF data, the BRIC countries accounted for nearly half of global growth in 2008 - China alone accounted for a quarter, and Brazil, India, and Russia were responsible for another quarter. Furthermore, the IMF notes that these economies accounted for more than 90% of the rise in consumption of energy and metals, and 80% of the rise in consumption of grains since 2002.

Canada is strengthening its trade ties with China in order to reduce its dependence on the US-economy. Canadian exports to China increased 6.8% in the five months through May, while exports to the US fell 26-percent. Thus, the gyrations of the emerging BRICK stock markets are of great interest to speculators in the Toronto Stock Exchange, the gateway to the world’s seventh largest economy.

One middle of the road approach to investing in global markets, between the high-flying BRICK acrobats, and the tortoise like markets in Europe, Japan, and the US, is the Toronto Stock Exchange (TSX) which contains a wealth of natural resource and high-tech companies, and a sound financial sector. So far this year, the Toronto Stock Index is up 20.5%, nearly double the +11% gain for the benchmark S&P-500 Index, but trailing behind Brazil’s +50% gain, and Shanghai’s +70% increase.

Canadian indices have outperformed their US-counterparts this year, energized by a rally in natural resource shares, which were supported by massive stockpiling of crude oil, copper, iron-ore, and aluminum by China’s Reserve Bureau. For foreign investors in Toronto stocks, there’s been an extra bonus, a foreign currency gain, due to the Canadian dollar’s advance against the Euro, yen, and US-dollar, on the back of surging base metal and energy markets. Still, the Brazilian real’s 25% gain against the dollar leads the commodity bloc currencies, while the Chinese yuan has gone nowhere, locked by Beijing at a fixed rate of 6.84 per US-dollar.

Roughly 45% of Canada’s gross domestic product (GDP) is linked to foreign trade, and 77% of its exports are sold to the United States. Each day, more than US$1 billion worth of goods crosses the US-Canadian border. So it’s not surprising that the Toronto Stock Index usually moves in the same direction as the Dow Jones Industrials, most of the time. However, the TSX outperforms when commodities are rising, which in turn, pushes up the Canadian dollar.

Because Canada holds the second largest oil reserves in the world, foreign capital inflows into and out of TSX energy companies are key drivers moving the Canadian Petro-dollar. Output from Alberta’s oil sands region, the largest crude reserves outside the Middle East, will rise to 3-million barrels per day (bpd) by 2018, more than double over the next nine years, from about 1.3-million bpd last year.

Canada has roughly 180-billion barrels of oil reserves, with all but six billion barrels locked in Alberta’s oil sands, a mixture of sand, water, clay and bitumen that’s too heavy to use without being heated. Oil must be priced at $65 a barrel for new oil sands projects to be viable, according to the Canadian Assoc of Petroleum Producers. Petro-Canada and Suncor Energy have joined forces to create Canada’s biggest oil company, a merger expected to save C$1-billion a year in capital costs and C$300 million annually in operating expenses.

But Canada also controls huge resources in iron ore, nickel, copper, zinc, gold, lead, silver, timber, fish, coal, petroleum, natural gas, and diamonds. Ironically, Canada’s minerals industry, including smelting and refining, only contributes about 4% to Canada’s GDP, yet lately, it’s the direction of base metals, especially copper, that’s increasingly influencing the direction of the Canadian dollar, subtlety dethroning crude oil, as the Loonie’s key lynchpin.

Canada is the third largest copper producer in the world, after Chile and the USA. It is also the world’s largest zinc and second largest nickel and lead producer. A small number of producers, including Noranda, Inco, Falconbridge, Teck Cominco, Boliden and Hudson Bay Mining, dominate base metal mining in Canada. Inco, owned by Brazil’s Vale, supplies a quarter of the world’s nickel, and also produces copper, gold and cobalt. Falconbridge and Noranda, owned by Xstrata Mining, mine nickel and copper at the world class deposits at Sudbury, Raglan and Kidds Creek.

Over the past decade, Canada has also emerged as one of the leading nations in the high-tech and computer industry, mostly located in Ontario and Quebec. There is also a large industrial base which includes companies that produce pharmaceuticals, aerospace products, and telecommunications equipment. About half of all Canadian manufactured goods are produced in Ontario, second only to Michigan, as the largest producer of automobiles and car parts in North America.

So while capital flows into base metal miners and oil company shares, lifted the Canadian dollar 20% higher, the larger population of Canadian exporters, the backbone of the economy, are hard hit by a stronger Loonie, since they receive most of their sales revenue in US-dollars. Canadian exports rebounded only slightly to C$29.3-billion in June, standing -36% lower than a year earlier. The Canadian central bank thinks the Loonie has run ahead of the trade weighted fundamentals.

On August 4th Canada’s finance minister, Jim Flaherty raised the possibility of central bank sales of Loonies, for the first time since 1998, if the Loonie’s sharp rise puts the fragile economic recovery at risk. “We are concerned with any rapid changes in the valuation of the Canadian currency vis a vis the US-currency. We watch that. There are some steps that could be taken to dampen that. There are, from time to time, indications of some speculation in the Canadian currency that is not justified in market terms,” Flaherty warned, blocking the Loonie’s advance at 94-US-cents.

Last month, Bank of Canada (BoC) chief Mark Carney hinted at stronger action if the Canadian dollar remained persistently higher than 87 US-cents, projected in the central bank’s quarterly report. The BoC retains “considerable flexibility in this regard, and will use that flexibility if necessary,” he warned. The central bank has already slashed its overnight loan rate to a razor-thin 0.25%, and could resort to experimenting with the hallucinogenic drug - “Quantitative Easing”– the printing of vast quantities of Loonies, in order to buy government bonds.

The BoC could engage in a combination of QE and sales of Canadian dollars, which in turn, has put a floor under the gold market in Toronto, at near C$950 /ounce. Interestingly enough, the threat of intervention has provided a temporary lifeline to the ailing US-dollar, which is crippled by massive budget deficits for years to come, and nearly $1.75-trillion of QE injections by the Fed. Thus, the Fed and the BoC are playing the old familiar game of competitive currency devaluation, where the appreciating currency is the least ugly.

Although the base metals have captured the attention of “hot money” traders in recent months, one should not overlook the hibernating Toronto gold market. The explosive growth of the Canadian M2 money supply, combined with an ultra-low 0.25% BoC loan rate through mid-2010, the possibility of unsterilized currency intervention, and QE injections, provide reasons for Canadian traders to buy gold on dips near support at C$950 /oz in the weeks ahead.

Trading in the Canadian dollar could become more hazardous if China’s central bank (PBoC) continues to issue more T-bills and restrains banks from lending recklessly. Beijing has guided the 5-year T-Bond yield about 65-basis points higher since early June, to the psychological 3-percent level, and is warning of a slowdown in bank lending in the second half of the year. In doing so, Beijing has sliced 600-points off the Shanghai red-chip market over the past two weeks!

For speculators in base metals and crude oil, it’s hard to believe that the PBoC would prick the Shanghai bubble, after working so tirelessly to re-inflate it. Chinese banks opened the flood gates this year, and are taking on more credit risk. China’s chief banking regulator Liu Mingkang said at a closed-door meeting in Tianjiin in April that the maximum Chinese banks should lend out a year is 6-trillion yuan ($878-billion), anything above that would be deemed as risky. During the first seven months alone, they lent out a whopping 7.7-trillion yuan ($1.2-trillion).

On August 14th, Mingkang urged the country’s top banks to closely monitor the flow of capital to prevent credit risk. New loans plunged to 356-billion yuan ($52-billion), less than a quarter of June’s level. “We should be clear-headed that the current situation remains very grim,” Liu warned. China Construction Bank, the nation’s second-largest bank, agreed to cut new lending by 70% in the second half to avert a surge in bad debt, President Zhang Jianguo said last week.

Of course, opinions in the schizophrenic currency and global stock markets can suddenly turn on a dime. After a doubling of the Chinese red-chip index, any unexpected bad news or signs of a deflating bubble can quickly trigger havoc in equity markets throughout Asia, rattle base metal miners and commodities worldwide, and in turn, trigger knee-jerk sales of Canadian dollars.

Yen carry traders operating in Toronto, keep a close eye on commodity markets, and perhaps, noticed the appearance of a “Hanging Man” candlestick pattern, - an important reversal top pattern, in the Shanghai index on August 4th. Canadian MoF chief Flaherty’s threat to sell Loonies on August 5th blocked the Canadian dollar’s advance at 90-yen. News that the Canadian economy lost 44,500 in July, with the jobless rate stuck at an 11-year high of 8.6%, helped to knock the Canuck buck towards 85.50-yen. The next shoe to drop was the TSX.

Comments

[yellowhoard:]

I can think of worse problems to have.

Canada is well positioned to come out of this Great Recession as our superiors.

Aug 18 09:03 AM

[john s. gordon:]

economically,
in former years when the u.s.a caught a cold, canada got pneumonia.
this time it's different.
> jack

Aug 18 10:05 AM

[auto44:]

Commodities, the real currency.

Aug 18 12:45 PM

[Uncle Pie:]

I don't know about "hanging man" candlestick chart patterns, but I do know that Canada has: No wars, No banking crisis, No energy crisis and No healthcare crisis. Canada enjoys a balance of trade surplus, in contrast to the US' deficit. Until the Great Recession arrived, Canada's federal government was in surplus, and is expected to return to surplus when the economy revives. No wonder the Canadian dollar is rising vs. the American dollar. In which currency would you like to receive your investment income? A question every investor should ask themselves.

Aug 18 12:50 PM

[AuGod!:]

Gary, I believe it is Kidd Creek Mine not Kidds Creek Mine and the Canadian dollar spot gold at 12:53 ugust 18, 2009 is CD1035.58 bid.

Aug 18 12:55 PM

[Donald Ingram:]

No. I don't think so. Not enough of a population base, with the US at ten times the size. I'm afraid that Canadians will continue to be "hewers of wood and drawers of water" for some time to come. Almost all the natural resource exports are in a form just one step up from their raw natural state.
Until there is secondary and down the line added value production and refining, the economy will continue to be held captive by resource speculators.


On Aug 18 09:03 AM yellowhoard wrote:

> I can think of worse problems to have.
>
> Canada is well positioned to come out of this Great Recession as
> our superiors.

Aug 18 01:03 PM

[yellowhoard:]

Canada could end up in the envious position of Switzerland.

With a strong currency and access to American labor, the Canadians could become terrific manufacturers of value added goods.

The Swiss bring in labor from adjoining countries in good times, and send them home when times are bad.

The oil sands alone will keep their banks flush with cash. Add in mining, timber, agriculture and gobs of WATER, and a very good case could be made for Canada going forward.

Frankly, a smallish population works to their benefit. They can more easily be able to afford their welfare state as a percentage of GDP.

Aug 18 01:40 PM

[Christopher...:]

Gary,

where did you get the data on the global speculators putting $35.5 billion into EM and pulling $61 billion from developed countries?

Aug 18 02:19 PM

[Moon Kil Woong:]

If Canada's currency wasn't so tightly pegged to the US$ their Looney would be above the almighty greenback already for 3 good reasons. They are more fiscally responsible even though they provide national heathcare, their banks are solvent and their government prevents their financial institutions from gambling with too much leverage, and their trade is not hopelessly imbalanced and running massive trade deficits that must be funded by junk Treasuries every year.

Although some like to make fun of Canada and their out of date pledges to the Queen, I can think of much worse things to be guilty of, such as a backward and corrupt financial system hopelessly divorced from reality and an out of date corrupt and incompetent government that lets the health and well being of its citizens slip towards dead last in the devloped world.

America needs to start solving its problems not just brush them under the rug. We pay more of our economy towards health care than Socialized France per capita. We have been hiding our drug problems by dumping people into jail without addressing the issue of addiction, and we have been engaged in the wanton destruction of our economy through mass trade imbalances for decades.

Even with all these problems, this still doesn't even begin to scratch the surface of our real problem the financial system's failures and the absolute level of wasteful government spending resulting in mass deficits, poorly run central bank, permanent easy money addiction, 0 savings rates, and a reckless can't loose gambling mentality by our banks. I thought /I would never see the day when America would fall behind Canada economically, but we certainly have. Come on America, get with the program! Even if we have to vote every elected official out in favor of libritarians and green party members to get the point accross to the Democrats and Republicans, we need real change and real reform and not the same dancing around false tokenistic solutions.

Aug 18 08:48 PM

[derryl:]

Very thorough and useful article, Mr. Dorsch.

Donald Ingram wrote, "No. I don't think so. Not enough of a population base, with the US at ten times the size. I'm afraid that Canadians will continue to be "hewers of wood and drawers of water" for some time to come. Almost all the natural resource exports are in a form just one step up from their raw natural state.
Until there is secondary and down the line added value production and refining, the economy will continue to be held captive by resource speculators."

There is truth to this. Aside from Southern Ontario and Quebec (where most of Canada's large scale manufacturing takes place) and Vancouver, most potential Cdn manufacturing or value added centers are too far from their markets to be viable. Cdn manufacturing tends to be specialty (like oilfield tools in Alberta) or other high value added but relatively low volume goods.

Alberta wants to upgrade and refine more of the bitumen it produces but labor costs here (I am Albertan) have been spiking since the recent run of tarsand plants construction. Chinese tarsands investors want to bring in their own labor from China. Texas and other US states in Alberta's downsteam can build refineries for half the price we can, so we ship raw material. The Alberta gov't has made deals to take bitumen in lieu of royalties in order to get raw material for an Alberta upgrader, which shows you that without subsidies this is an uneconomic endeavor. The newly combined Suncor and Petrocan will be upgrading, taking advantage of Suncor's low cost tarsands extraction and Petrocan's wide retail presence in Canada to make the economics of tarsand-to-gaspump work for them.

Alberta only has 3 million people and already much of our labor force is Cdns from other provinces, and immigrants. Alberta is nearly the size of Texas, which gives you an idea of how sparsely populated the province is, and most people live in the Edmonton to Calgary corridor. Alberta's population distribution is fairly typical for Canada as a whole, so it's easy to see why Cdns continue to be hewers of wood and drawers of water.

On the upside, there's (usually) lots of money to be made producing commodities so if that's Canada's near term future I can think of worse fates. The Montreal Institute recently published a plan for large scale water diversion through Quebec into the Great Lakes, with hydro plants along the route, which could make future water and electricity sales to the US a profitable venture. And as Gary Dorsch notes, Alberta has massive reserves of oil, plus coal and natural gas, and Canada is rich in a range of other resources.

Besides all that, from Canada's Northwest Territories you can see not only Russia but Sarah Palin too!

Aug 18 09:06 PM

[Econ Base:]

The Canadian stock market (and Australian) and their currencies for that matter are tied to commodity prices. You can plot historical charts to get to this conclusion. China has been on a buying spree of commodities, trying to diversify out of the US dollar. When that Chinese appetite is fulfiled and markets return to normal supply and demand, then watch out for a commodity AND Canadian/Australian stock market and currency correction.
Stay balanced. Good luck!
portfolioforlife.blogs...

Aug 19 12:22 AM

[bob adamson:]

I am a Canadian living on our West Coast. Mr. Dorsch's article is well reasoned. As is often the case for Americans commenting on Canada, several of the postings following the article use Canada as a foil to discuss the apprehended strengths or weaknesses the writer sees with the US currently. I have no problem with this and note the same in reverse often ocures when Canadians comment on US affairs. My take on the current Canadian situation is a bit different. While the strengths noted by 'Uncle Pie" are there, they are offset by our dependence on foreign trade, particularly in commodities. In other words, we start with a well managed economy but one particlarly exposed to the ups and downs of the global economy (and especially that of the US). In short, we'll do OK but our sustained recovery will be bounded by that (or the lack thereof) in the US.

Aug 19 02:22 AM

[bob adamson:]

I am a retired lawyer living in British Columbia on the west coast of Canada

Aug 19 02:26 AM

[SeeTheLight:]

With Shanghai tanking, its only a matter of time before the TSX catches on. I've sold most of my longs in anticipation of a pullback. Commodities may provide some cushioning for the Canadian economy but it will be very volatile trade with the Loonie moving rapidly in response.

Still, I do agree with most of the posters, that Canada is better positioned relative to the US when the eventual recovery occurs.

Aug 19 04:19 AM

[Michael Clark:]

Isn't Global Warming (err, I mean 'Climate Change') going to cure a lot of problems for Canada, opening up unfrozen lands for a new wave of immigration and resource exploitation?


On Aug 18 01:03 PM Donald Ingram wrote:

> No. I don't think so. Not enough of a population base, with the US
> at ten times the size. I'm afraid that Canadians will continue to
> be "hewers of wood and drawers of water" for some time to come. Almost
> all the natural resource exports are in a form just one step up from
> their raw natural state.
> Until there is secondary and down the line added value production
> and refining, the economy will continue to be held captive by resource
> speculators.

Aug 19 06:28 AM

[rrheyn:]

Yellowheart , it depends how we look at it.
I hope that no originals, Indians take that as an advice ;))
or they put all the emigrants from Europe in camps, like we have done with them . That would be a real reverse lesson.


On Aug 18 01:40 PM yellowhoard wrote:

> Canada could end up in the envious position of Switzerland.
>
> With a strong currency and access to American labor, the Canadians
> could become terrific manufacturers of value added goods.
>
> The Swiss bring in labor from adjoining countries in good times,
> and send them home when times are bad.
>
> The oil sands alone will keep their banks flush with cash. Add in
> mining, timber, agriculture and gobs of WATER, and a very good case
> could be made for Canada going forward.
>
> Frankly, a smallish population works to their benefit. They can more
> easily be able to afford their welfare state as a percentage of GDP.
>

Aug 19 08:56 AM

[geewow:]

Mr. Dorsch, great article! Very thorough with your views on what is going on with the Canadian markets. One commentor stated correctly that the Canadians can work to create a functioning country since they are NOT so stupid as to start wars and waste precious resources maintaining them; and, they control health care costs by nationalizing their system, as well as control leveraging and "creative securitization"; and finally, hold on to their manufacturing base.

What is wrong with the US government is that that don't want to take a lesson from the Canadians. Canada is like the youngest sibling in a family of three. They tend to watch what the other two did wrong, and how they related to their parents, ie. other nations, and then, do it better, and with more sense.

Mr. Dorsch, are you REALLY George Clooney in disguise? :)

eye-on-washington.blog...

Aug 19 11:02 AM

[bob adamson:]

The 'unfrozen lands' in question are the Taiga (thick band of forest around the artic circle) and, above that, the treeless Tundra. Climatic warming is thawing the Taiga's permafrost turning the region into swampland with unstable trees and introducing new animals, insects and plants which destroy those already there. Permafrost melting and ecological shifting are also issues in the high artic Tundra. Significant climatic warming would degrade the Tundra and Taiga but it would take hundreds of years for these degraded lands to adapt into their southern counterparts to become suitable for agriculture etc.


On Aug 19 06:28 AM Michael Clark wrote:

> Isn't Global Warming (err, I mean 'Climate Change') going to cure
> a lot of problems for Canada, opening up unfrozen lands for a new
> wave of immigration and resource exploitation?

Aug 19 11:20 AM

[Marky61:]

To Mr. Ingram: This is Canada calling; time to hand in your Blackberry for that nasty comment about hewers of wood. In all seriousness, there is a lot of technological innovation going on up here that doesn't always see the light of day. Part of the problem is that U.S. companies vacuum up our entrepreneurs before they really get started. Much like the film industry. There wouldn't much of a Hollywood if it wasn't for the half-million Canadians working in SoCal. Say, what was Research in Motion just named the other day?

Aug 19 02:25 PM

[MILESCFA:]

On Aug 18 12:50 PM Uncle Pie wrote:

> I don't know about "hanging man" candlestick chart patterns, but I do know that Canada has: No wars, No banking crisis, No energy crisis and No healthcare crisis....

Canada is one of America's closest military allies, so please ask the family's of the 127+ Canadian soldiers who've died in Afghanistan since 2002 if they are involved in a war.

Admittedly - it seems - Canadian banks are in much better shape than US banks, but I don't know Canadian accounting (mark-to-market?) and I've read the Canadian government has guaranteed 125 billion in the last couple of years, but since it's a guarantee it isn't on the Canadian bank's books. Who knows? Not me, but I doubt Uncle Pie knows either. The Canadan government is also buying mortgages from their banks but the C.gvt charges such high fees that the C.banks are NOT selling.

Everyone knows Canada does not have an energy crisis but it's because Canada's economy is a "commodity economy", so that statement is like saying the middle east has no shortage of sand. I bet the Candian lumber industry is hurting since the US is not building so many houses. When China stocks stockpiling commodities, I would not want to be in the Canadian commodities business.

As for health care, do you really want Canada's health care system (20/20 John Stossel's report)... abcnews.go.com/video/p...

Finally, if commodites are going up, the Candian dollar is going up.

I don't win any points being critical of other commentators, but it's an attempt at constructive criticism when I see people shooting from the hips(?). Admittedly, I'm a fiscal conservative because I've seen very few government programs that work well, because if they do, the politicians say "This works... let's expand it." They do until "the Peter Principal" comes into effect.

As Dr. Milton Friedman like to say, "If a government were put in charge of the Sahara Desert, within five years they’d have a shortage of sand."

Aug 19 09:43 PM

[bob adamson:]

As of October 28th the relative advantage that Canada has enjoyed over the past two years is decreasing somewhat. If there is now a downturn, don't expect Canada to avoid sharing more fully in the pain.


On Aug 19 02:22 AM bob adamson wrote:

> I am a Canadian living on our West Coast. Mr. Dorsch's article is
> well reasoned. As is often the case for Americans commenting on Canada,
> several of the postings following the article use Canada as a foil
> to discuss the apprehended strengths or weaknesses the writer sees
> with the US currently. I have no problem with this and note the same
> in reverse often ocures when Canadians comment on US affairs. My
> take on the current Canadian situation is a bit different. While
> the strengths noted by 'Uncle Pie" are there, they are offset by
> our dependence on foreign trade, particularly in commodities. In
> other words, we start with a well managed economy but one particlarly
> exposed to the ups and downs of the global economy (and especially
> that of the US). In short, we'll do OK but our sustained recovery
> will be bounded by that (or the lack thereof) in the US.

Oct 28 06:48 PM