Canada’s September TIC report

Foreigners’ love affaire with Canada continues unabated, although the flow direction has changed somewhat towards bonds – to levels only second to the January 2009 amount. Non-residents acquired $8.8 billion of these instruments in September, focusing on US dollar and Euro denominated private corporate and provincial bonds.

Non-resident investors purchased $3.6 billion of Canadian private corporate bonds in September, following acquisitions of $5.3 billion in August. This activity was dominated by new bonds issued by resource and financial firms.

Foreign investment in federal government bonds leveled off in September, accounting for a $1.9 billion inflow of funds from abroad. Federal bonds have attracted sizeable foreign investments since January 2009, with foreign holdings of these instruments more than doubling since then.

Although the risk associated with the Canadian economy remains positive – in fact Canada’s economy is underperforming its southern neighbor in Q3/2010 (and possibly also in Q4/2010).  The risks associated with Canadian securities remains attractive, however, the Canadian dollar’s volatility and high correlation to oil prices make it an unattractive play for foreign investors.  Asset swaps are the name of the game.

Part of the dilemma for foreign investors is that the Canadian dollar is highly correlated to oil price, up to the point where the Canadian dollar reaches parity with the US dollar, thereafter the correlation breakdown.  It may have to do with the other high correlation with the S&P500 (also in the high 70s), when oil prices breach the $85/bbl level the drag on the U.S. economy becomes too strong (anyway its an hypothesis).

Bottom line foreign investors want Canadian exposure with no foreign exchange exposure.