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Loonie bets.


“It is very difficult to make an accurate prediction, especially about the future.” – Danish Physicist, Niels Bohr.

For the first time in a generation, Snowbirds can convert Loonies to US$’s at par. For Canadian investors, however, the question is ‘where to from here’? Market prognosticators argue continued Loonie strength or inevitable decline.

Our Loonie usually follows the US$ and commodity prices (interest rates too). Loonie bulls argue that because most everything that Canada sells is in demand and at high prices, this means Loonie strength.

Of major importance is oil. The US consumes 2 ½ times the oil of China and India combined and oil is a top Canadian export. 65% of our oil goes to the US. Lombard Research says, however, that US growth will be “scarcely above zero”. A slower US economy must mean less demand for Canadian oil.

Eric Sprott, on the other hand, says that ‘oil prices might stay high even in a recession’. And Talisman’s Jim Buckee says that to reach ‘demand destruction’, oil may have to hit $120.

Metals and minerals – also major Canadian exports – are sensitive to continued economic growth. Slower US growth means less US demand for Asian products, thus slower Asian growth and hence less Asian demand for Canadian commodities. Levi Folk argues ‘slower US growth will have repercussions for commodities exporters’. “Canada will not be immune”. The key Loonie risk, says Global Insight, is a US slowdown.

Harris Bank’s Don Coxe, in contrast, says that the US$ will decline until the US get’s its fiscal house in order. Until that happens, expect ‘real pain in Canada’ by way of a yet higher Loonie.

But the Bank of Canada’s currency model says the Loonie should be $0.91. Export Development Canada says $10 of oil price equals 3 cents worth of Loonie. The Loonie ended 2006 at $0.86 when oil averaged $60. With oil now at $80, the Loonie should be at $0.92.

Standing on the fence, BCA Research says a weaker US$ means less commodities price pressure and that things are “just right”.

Sigh.

Predictions are seldom exactly right or wrong. The beauty of diversification is that investors only have to be approximately right.

So, rather than make a Loonie bet, expose your portfolio to opportunities across asset classes, geographies and currencies, including Canada. Diversification across many different sources of income and growth will mean more stable returns and moderated portfolio volatility.

If predictions for a weaker Loonie are correct, expect currency returns from your international investments. In contrast, Loonie strength will mean continued returns from your Canadian investments. In either case, expect dividends and interest income.

Originally published in the Business Thompson Okanagan news, November 2007.

Doug Cronk CFA is Manager, Investments for a Canadian Pension Fund.

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