Today we had the release of the quarterly COFER Report. This report is issued by the International Monetary Fund and shows the amount of money in US dollars that Central Banks are holding for reserves. This year the Canadian Dollar (FXC, UUP, UDN) has been added as a choice for the Central Bankers to include as reserves. This report showed the bankers added USD 2.654 trillion in the third quarter of 2013.
Prior to the release of this number showing the Loonie was in demand from the CBs, the US dollar had strengthened, trading above 1.07, near the high for the year. It is great for the C$ to be added to the big time currency players, but the amount of Canadian dollars held in reserve by the bankers, $112T, is far less than the CB's USD holdings of $3,083T. Besides, the reserve holdings of US dollars went up about $52T for the quarter, far more than the $2.7T Canadian.
We might also compare the size of the CB's purchases to the specs position at the CME futures market. The COT report released yesterdayshowed specs are short 74,960 contracts. Each contract is $C100K which is worth around $US94K. Thus the activity of the bankers, though interesting, is from the third quarter, and is less than the net short spec position in the CAD of $US 7.046T.
As we have often mentioned, the most important fundamental in a currency pair is the flow of funds. Granted the panoramic view of all currency trades are hidden from the public, so we must look at the futures markets because, there, the trade is visible. Over the past two months the spec has become increasingly bearish. The total spec short position in the Canadian dollar has gone up 55K contracts to 75K.
During the past year there were times when we thought the Loonie could gain against the USD, but this did not work for two major reasons. First the US economy, if we are to believe the official numbers, grew faster than expected. This has resulted in the taper, and perceived as friendly to the USD. As a result of faster US growth, 10-year bonds are priced to yield about 20bp higher than the Canadian, making the USD more attractive.
The other reason the Canadian dollar has been on the defensive is the weakness in commodities and the commodity currencies, Canada and Australia in particular. This may not be justified but Canada, a major supplier of oil to the US, has encountered difficulties. The price for this oil is at a big discount to other oil supplies primarily because of the quality and location of the oil. For example, now late in December of 2013, Western Canada Select is worth about $78 a barrel versus a trade in WTI of $101 a barrel.
Marketing Canada's vast supply of natural gas is likewise difficult. Prior to the North American shale energy revolution, Canada sold the natural gas to the US. Now, the major markets for the natural gas appears to be in a liquid form to both Asia and Europe. But the Canadians are late entries in the race to turn natural gas into a liquid with oil majors in the US and Australia leading the charge. British Columbia voters did give their government approval to construct pipelines to transport the gas to the West Coast where it will be converted to liquid form and shipped to Asia, but this is a project that will take years complete.
So who will win the battle between the CBs with their deep pockets and the nimble specs? There was a very interesting article in Market Watch today by Ivan Martchev who says:
"The most hated monetary instrument on the face of this planet has to be the U.S. dollar.
If we could calculate a ratio of dollar bears versus dollar bulls, it should skew to at least 9:1 in favor of the bears and I could very well may be underestimating it. But, with QE unwinding and real interest rates rising, the seeds have been sown for a dollar rally. How far that rally goes depends on how far the Federal Reserve allows it to go.
The two developed market currencies most at risk are the Canadian and Australian dollars, which have already been weakening in 2013 due to the pressure on hard commodities as both economies are disproportionately exposed to them."
Some interesting items when we look at the charts. Since we are looking at longer term trading opportunities, let's start by looking at the monthly chart. There we see the beginning or a saucer bottom that began around the end of 2009 at about 107.50, the level of today's low versus the USD. This is a very large bottom. and should the USD take out the recent high, this could eventually could result in the USD going back to the 1.20 level. The monthly MACD shows the USD has turned to the upside.
The weekly chart is also quite interesting as it is flirting with a trend line break out to the top side. So far the bear market has been orderly when compared to the USD. The daily chart from today shows a reversal back toward the 20-day moving average around 1.0650. We wish to try the long side of the USD versus the CAD in the 106 to 106.50 area. As always mind your money.