Wednesday, October 5, 2011

Currency talk – the CAD in perspective



First, the CAD is a Petro Currency, it is most affected by the price of oil (and not coal) and for the past few weeks oil prices have dropped dramatically, due in part to the risks of recession (maybe) in the U.S. and of collapse (looking more likely) in Europe.  First, there is no doubt that the Euro is heavily overvalued, from the Big Mac Index all the way to PPP analysis they all scream to the fact that the Euro is just making Europe uncompetitive.  Proof is that the bulk of its trade in internal (this is a newish phenomenon).

So the CAD has lost about 6% of its value over the past 3 months – when oil price (WTI was flirting with the high $80s).  So far so good, but the AUD has fallen by 9% and the Brazilian real has loss nearly 1/5th of its value against the greenback.  So the CAD  has held its value rather well.

The CAD’s reality is that it behaves as a petro currency but in fact oil only accounts for a small percentage of its exports (I include gas here), in reality Canada is much more than that (especially for foreign investors who have been pumping money into Canada – to the tune of 8% of the GDP for the past 2 years – which is a lot).  The likelihood that the CAD will drop to the mid ‘80s against the USD are remote, although it could flirt with the low 90s over the next few weeks – a combination of reasons – investors seek the safety of the USD, so there may be some short term outflow out of the CAD (mostly in the form of Gov’t of Canada T-Bonds/bills).  This would not be the end the world; in fact it may push up short term rates. 

My view, and I’ve maintain this for some time, is that CAD could easily revisit the low 90s levels, nothing to do with Canadian activity, rather the risk of American slow down (and the high likelihood that Europe will do something stupid – rather via their inactivity European governments will cause the worse possible outcome).  However, the CAD will not stay low for long – because location conditions are just too compeling for investors:
  • An right of centre government looking to achieve balance budget b 2017
  • A general agreement on the right policy mix (the disagreements are at the margin)
  • Well educated labor force with limited wage differential
  • Medical costs that are nearly under control (and more than 10 health care systems)
  • Heavy investment in infrastructure (long overdue) across the country

I don’t want to address the China issue – frankly when Steven Roach says a “soft landing” in China is likely all bets are off (this guy was a bull stating that the Chinese growth would continue unabated until a few weeks ago – clearly something, on the ground in China, has changed!).

Over the medium term the Canadian reality is attractive to foreign investors, economy is well balanced, and while the housing market is on the expensive side national income is rising.

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