Has The Loonie Sell Off Gone Far Enough?

by: Ralph Shell

At the end of last year I wrote the Canadian Dollar was likely to lose value to the U.S. dollar. At that time the USD was trading near the 106 handle where we felt it should be owned. In the days following some of the economic news coming from Canada has been discouraging. The Canadian Trade balance fell short of expectations at a Negative C$940M. The IVY Purchase Managers Index was far less than expectations, 46.3, well short of expectations, 55.4, and last month's 53.7.

Then it was no wonder, considering the freezing temperatures, that the number of building permits issued was sharply lower. This was followed with a surprising increase in Canadian unemployment, up to 7.2% from 6.9% last month.

In the US, aside from the NFP report, most of the US economic news was favorable. As the USD forged into new high ground, above 1.0720, the momentum players entered the market buying the USD. This new buying of the USD sent that currency up to a high of about 1.0940. Looking at the longer term charts, the trend remains to the upside. However,if we look at the history of the USDCAD, this is a gradual trend, one which will likely play out over months. Consequently, we would not be surprised if the trade from 1.0950 to 1.10 might be a level of substantial resistance.

In addition, there might be some things working in the Loonie's favor. Though the Canadian economy is much more than just the energy sector, it is one of the most important drivers of the Canadian economy. We have noted that the Canadian development of the oil sands is producing an ever increasing quantity of heavy oil, which because of location and quality trades at a discount. This oil, referred to as Western Canadian Select, was priced at a $23/dollar a barrel discount to WTI, at the first of 2014. Now only 16 days later, the discount has narrowed to only $12/barrel. While this may not result in a big boost to Canadian trade dollars, it is psychologically supportive to he currency.

Other developments which would benefit the Canadian dollar is a rumor the Keystone XL pipeline is going to be approved. This is a project, originally proposed in 2008, for the transporting 830,000 barrels of oil per day from the Canadian tar sands, through the North Dakota, to Oklahoma, then connecting to the Gulf Coast refineries.

Since 2008 Canadian oil production has increased by 700K barrels per day, and US North Dakota production has increased by 1.5M barrels per day. All involved in this project would benefit. The Canadians would have a better market for their growing supply of oil, as would US producers in North Dakota, and there would be construction ready jobs for up to 20,000 US and Canadian workers.

Currently Canada produces about 4M barrels of energy per day. Their consumption is 2M bpd and their refining capacity is about 2.4m bpd. But a surplus of refining capacity at the US gulf exists, creating a demand for the heavy crude. This supply would allow the US to expand exportation of value added refined products to Central and South America.

The Keystone project sounds like a winner for all concerned but the final decision has been delayed for years by a dithering Washington administration. There are now emerging whispers Obama is going to approve the Keystone Pipeline XL in the State of the Union Speech. Should the rumor gain momentum, this might make some of the bearish CAD crowd cover their short positions.

The market is again approaching the 1.10 level. Today the buying of the USD may be against the selling in the European currencies. Our preference is to fade the rally (USDCAD, FXC, UUP, UDN) around current levels, but carefully monitor the trade. Perhaps it is best to risk only a small position today, and plan to add to it should the market retreat Monday or Tuesday next week.

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.

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