Can The Canadian Dollar Again Trade At A Premium To The U.S. Dollar?

Includes: FXC, UDN, UUP
by: Ralph Shell

Once again the Canadian dollar is firming versus the U.S. dollar, challenging parity with the greenback. Looking at the chart there is a distinct channel starting from June 4th when the USD made a high of 1.0445 versus the loonie. From initiation of the channel we have a succession of Canadian dollar highs followed by spikes of USD strength. Clearly there is a pattern of Canadian dollar strength, but once again we have approached parity, where there should to be resistance.

The lengthy US/Canadian border and the North American free trade agreement has encouraged big trade between the two countries. According to a recent Fact Sheet from the US State Department, there is daily trade of $1.6B. Each day 300,000 people cross the Canadian/US border. The two countries supply electricity to each other, sharing a huge electrical grid. The US buys 70% of Canadian exports. The US is the largest investor in Canada, and Canada is the fifth largest investor in the US. Economically the two countries are bonded together.

Like many of the world's economies, the Canadian economy has been slowing. A recent report showed the Canadian economy had GDP growth on a m/m basis of only plus 0.1% down from 0.3% in the prior month. This will cut yearly Canadian growth to around 1.5%, respectable but not enough to cut the 7.2% unemployment rate.

The Canadian economy, according to most 2011 statistics, with a GDP of $1,737T, ranks tenth in the world, ahead of India, but behind Russia. Since the beginning of 2012, exports from Canada have been slowing, and the strong loonie may be one of the reasons.

For years Canadian manufacturers benefited from their discounted currency, and the discounted currency resulted in many US companies moving facilities to Canada. Auto manufacturers moved into Canada and took with it the elevated wages of the United Auto Workers.

The North American Free Trade Agreement may have helped Canada, but not Ontario auto workers. For 2011 Canada produced 2,134,893 vehicles, up 3.2%, but Mexico had a 14.4% increase in production, and produced 2,680,037 cars and trucks. With new plants coming on stream in Mexico as well as the non-union southern part of the US, this trend continues. The days of ample $30/hr manufacturing jobs in Ontario may be ending.

Offsetting the decline in manufacturing activity in Canada has been mining, and oil and gas extraction. While these segments of the economy have been bright prices have been soft. The US was formerly a busy buyer of Canadian gas, but because of the energy revolution in the US, gas prices are lower and the US has a natural gas surplus.

Oil demand from the US remains good, making a market for oil sands production in Alberta. This is heavy oil which trades at a discount, far away from refineries, and requiring big transportation costs. Today for example, the spot West Texas Intermediate is trading at 88.42. The oil sands crude trades at a discount, at times, over $20/barrel. In June it traded as low as $40/ barrel. No wonder why the Canadians want the Keystone pipeline to be constructed.

Global economic news does not favor expanding or robust economies. Until that reverses we doubt the Canadian dollar has much more to gain on the USD. Further should the Chinese or European difficulties worsen, what are the chances energy prices could sell off? The end of the North American peak driving season often signals lower energy prices.

We prefer the short side of the Canadian dollar versus the USD at these levels, risking 75 points. Should we get a perfect storm, poor economic numbers and deleveraging in the oil futures, this pair could trade at 1.04.

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