Canadian Loonie Versus The Australian Dollar

Includes: FXA, FXC
by: Grant Dossetto

Canada and Australia are similar countries in many ways considering that one is a mostly arid island sitting in the Southern Hemisphere and the other is a sprawling, sparsely habitated forest which reaches the extreme Northern Hemisphere. Both countries are former British colonies, except for pesky Quebec, who share a common culture. From an economic perspective, the countries are resource rich, developed nations whose currencies are intertwined with the strength of commodities markets. For this reason, the two currencies move in tandem. This can easily be proved through statistical correlation, the following table shows a 95% correlation between the exchange rate of the US Dollar and the Australian Dollar against the exchange rate of the US Dollar and the Canadian dollar from the period of March 2009 to July 1, 2010 based on 408 data points:

USD/CAD 0.952054 1

The data from the middle of this decade paints a similar picture. This correlation has broke down twice in the past ten years. The first example is from November 2007 to May 2008, the US currency gained approximately 12.5% against the Loonie while it lost approximately 6% against the Aussie. The second disparity began in July of last year and has continued to this day:

These time periods have definitive characteristics of financial market turmoil and a commodity bull market. It appears that we are nearing the end of this cyclical bull market, a mighty effort to last over 2 years in one of the worst secular bear climates of the past 80 years. Much as in the second half of '07, world economies have fallen while the US treads water. Bulls claim that this the US market can decouple from the rest of the world, bears, of which I am one point to history and say the US is lagging the world. Evidence of this lag can be seen here here.

It can also be found in trade, as denoted by shipping rates. Manufacturing tells a similar story:

Chinese and German PMI indexes now note contraction. That differs from the United States:

Australia's mining and agriculture sectors account for over half of its exports. The country is very vulnerable to a slowdown in the Chinese property market, something already being seen by property developers and soon to be felt by banks who financed the construction. The Australian central bank is already cutting interest rates compared to stability from the Bank of Canada. I expect that the divergence between the USD/AUD rate and the USD/CAD rate will disappear within six months.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.