Will The Loonie Bears Get Their Payoff?

Includes: FXC, UDN, UUP
by: Ralph Shell

The loonie bears aka known as the Canadian Dollar shorts have built a large position during the early part of 2014. As reported in the last COT report, specs were short 77,412 contracts at the IMM. This compares to the even bigger spec short in the Japanese yen, 113,612 contracts. The yen bears have been holding their positions for over a year, and only recently begun to reduce their holdings, but for the C$ bears, their shorts are more recent.

Most of the weakness in the C$ came after the USD broke out above 1.07, and very briefly traded above the 1.12 handle before retreating to almost 1.09. There is something peculiar about this move. Namely, most of the short position was established before the move commenced above the 1.07 handle. Further, as the C$ weakened, the open interest did not grow. Shorts were not convinced the USD would continue the rout of the C$.

Some of the rational for the lower loonie may have come from a luncheon where a NY Fund manager, Joe Carson with Alliance Bernstein gave the audience reasons why the C$ would go to C$1.20 or perhaps C$1.30. Carson said:

"The C$ was too high for too long, in part because of the commodity boom, which resulted in the loss of thousands of manufacturing jobs. Once those jobs disappear to other parts of the world, they don't return, because in Carson's view, "technology has changed the way manufacturing takes place. Technology makes production mobile," he said." Carson illustrates that point by the performance since 2000 of the three parties to the NAFTA: the US and Mexico have both seen a 25% increase in the output of durable goods; in Canada output is down by 15%. "Canada has lost its way," he said.

A stronger economic rebound in the U.S. relative to Canada, which will bring higher interest rates faster in the U.S. than in Canada. Indeed, Carson expects Canadian monetary policy to remain "on hold" until the end of 2015. He expects the US economy to grow by 3.1% this year while predicting 2% growth for Canada;

Canada's cost structure. Carson argues that labour markets in the US are more flexible than in Canada and employers are not shy about moving production elsewhere from Canada if they don't get the concessions they want. In contrast he argues that the US is a "low cost producer," a situation that allows it to secure a number of new plants for the automobile producers."

There is no doubt that the same unions that brought Detroit to its knees have been busy in Canada. With the exchange rate advantage gone, it was just a matter of time until the high paying union manufacturing jobs would be moved to Mexico or the US South. This is not new and certainly no surprise.

Did the commodity boom hurt Canada? Certainly some of the investors in the junior mining stocks did not fare well but the big commodity contributor is crude oil. Canada's share of the oil revenue is smaller because of higher transportation costs to the refiners, and the need for more pipelines. That notwithstanding, the price for Western Canada Select is currently only a $15/barrel discount to WTI crude which is trading above $103/barrel. There have been times when the discount of the Canadian crude has exceeded $25/ barrel, so the oil market has helped Canada.

But what about Mr. Carson s other predictions. Certainly with the US ten year bonds currently yielding 2.70% compared to 2.51% for the Canadian, his prediction is right on. For the GDP, 3.1% for the US, and 2.0% for Canada, this may be subjected to some revisions.

On Friday we do get GDP estimates. In the US, the Annualized Q/Q estimate has been reduced to 2.5%, from 3.2%. The nasty winter in the Eastern US will take its toll. Another head wind for the US economy is the turmoil caused by the confusion of Obamacare, and its impact on business. Ultimately the 2.5% US growth may be optimistic.

Stats Canada has a different way of measuring their GDP. They estimate the GDP on a monthly basis, and then make a seasonable adjustment to arrive at a yearly estimated GDP. For the month they estimate a -0.3%, down from a positive 0.2%, but for the year their projection for growth is 2.5%, the same as the US estimate.

It seems that based on the GDP numbers alone, bearish Canadian numbers might be anticipated, but the US numbers may have more difficulty achieving what is anticipated. Considering the big USD long, that side of the market might be vulnerable. The safe trade might involve selling of the USD should there be a retrace of the 1.12 high. (USDCAD, FXC, UUP, UDN)

Looking further into the future, is it possible that the conventional bearish wisdom regarding the Canadian economic growth might be too pessimistic? After all, the snow is about to melt in the tundra. Who knows what opportunities the hearty Canadians will find once the snow and ice melts. What happens if Obama finally approves the Keystone pipeline. Approval would result in about 20K new jobs there. By the time they ring the bell at year's end, we may find the Canadian economy outpaces that in the US.

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.