How Do We Trade The Loonie?

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Looking at the daily chart in the loonie, (USDCAD, FXC) the trade has been rather sedate. In September, we had the specs loaded long, in part because the Fed's Bernanke was about to embark on the newest version of quantitative easing. The longs briefly took the pair to .9650 in the September rally and were then blown away. (As the price goes lower, this represents a weaker USD and a stronger C$.)

After visiting parity with the USD, another gradual accumulation of the C$ as well as other commodity currencies occurred. As they say, those standing nearest to the new money get the biggest share. That would be the investment bankers and others close to the bankers, whose collective wisdom decided the new money was bullish on commodities, specifically oil, and commodity currencies.

During the month of January, the buying enthusiasm for the C$ waned. Though the employment numbers in early January were good, there were several economic reports showing the Canadian economy lacked vigor. Building permits were down 17.9% -- much more than expected -- the trade balance was at a negative C$1.6B -- a big drop -- foreign securities purchases at C$5.6B were less than expected, and Retail sales showed a monthly drop of 0.3%.

Today, there was a positive PMI report from Ivey, 58.9, well above the expected 53.9 number and the previous month's 52.8. Later this week, we get other meaningful Canadian numbers, Building Permits, a new trade balance number and unemployment numbers. Should this week give us a rally in the C$ toward the .9935 area, we are inclined to be a seller.

There are several reasons why we favor this approach. Though Canada rightly has the perception they are a commodity producing country, they are also a major manufacturing nation. But Canada is a handicapped manufacturer because of high labor costs and the strong C$. Many of the manufacturing facilities were built when the loonie was at a discount to the USD, easily facilitating exports to the US. Now, the new plants are going to the U.S. South and Mexico, where labor and energy is cheaper.

Canada's biggest commodity export is oil. The estimated reserves when the oil sands are included rank Canada right behind Saudi Arabia and Venezuela. Unfortunately, the biggest share of these reserves are in the form of bitumen sands located far from refiners and consumer markets. The sands require massive investments to extract the oil, and transportation costs are quite high.

Suncor Energy Inc. (NYSE:SU), Canada's largest energy company by market value, today reported a quarterly loss of C$562M. Part of this loss is because of the weakness in the oil price in Alberta. The Financial Post reports:

"The price of Canadian heavy crude, produced at oil sands operations such as Suncor's Millennium mining site, declined 25% to an average of $61.32 a barrel in the fourth quarter from a year ago, according to data compiled by Bloomberg."

Canadian Oil Sands Ltd. (OTCQX:COSWF) is another oil producer that had lower earnings, C$221M, down from C$232 in the previous year, despite higher oil production. The problem is the steep $40/barrel discount to the WTI crude. Should these market conditions continue, both companies will be reducing investments in oil sands production.

This price per barrel represents a discount of $40/barrel from West Texas Intermediate, and $55/barrel from Brent crude. There is no doubt this oil price would increase with additional pipelines, but construction of the Keystone pipeline has been stopped by President Obama.

The Keystone pipeline has been proposed to transport the Alberta sands oil, and the Bakken shale oil from North Dakota, south to the Texas refineries. It would have a capacity of about 900K/barrels per day. Despite about 26,000 miles of pipeline crossing the U.S., this one has been targeted by the environmentalists to be stopped, and the President has concurred. Currently, much of the North Dakota oil is being hauled to market by the Burlington Northern railroad. This is immensely profitable for the railroad owned by Warren Buffet, a big benefactor of Obama. Do not be surprised if the Keystone construction is again rejected.

Longer term, there is another threat to exportation of Alberta oil to the the U.S. The improved drilling technology and the ability to recognize and report the type of rock formation to a computer while the drilling is going on will open new oil plays.

Recently, oil developers have been gobbling up oil leases in the California Monterey formation. Because of the San Andreas fault, this is a complicated play. However, the U.S. Energy Information Agency estimates there are over 15 billion barrels that can be recovered with today's technology. That is more than the reserves in the Bakken and the Texas Eagle Ford combined.

Today, someone said that Europe needs a strong currency as much as a submarine needs a screen door. Canada, likewise, would be hurt by a strong currency at this time. As always, manage your money. We must deal with what it is, and not what we want it to be.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.