Does Everyone (heart) the Canadian Dollar?

Let me get this out of the way: I very much admire the economic performance of Canada. In an age when dysfunctional economic performance is thick on the ground, Canada manages that rarest double for a developed economy--trade and budget surpluses. As a result, the Canadian dollar has performed very well as of late, even if it suffers from a negative yield differential compared to the US dollar. Some skeptics said the loonie (Canadian dollar or CAD) would depreciate as the US dollar's yield surpassed that of the loonie, but that hasn't happened. In fact, the currency has just reached a 13-year high this past week.

In a related matter, what exactly do they mean when they say that the loonie is a "commodity currency"? I'm grabbing the following charts from a Canadian government site. The printers were remiss in omitting the x-axis labels, but each vertical line represents a year starting with 2000 and ending with 2004 (these are the latest numbers I could find):





Two observations: (1) The Canadian dollar tracks changes in commodity prices quite well. I did a study once back in graduate school correlating the movements of gold and the loonie with those of some commodity indices and found that CAD wasn't far off the pace of gold--a commodity itself! I'd kill to have a Bloomberg machine in front of me right about now to run an update. (2) Roughly 80% of Canada's exports are US bound. The correlation of that country's exports to the US and overall exports is simply breathtaking.

What can we learn here? The Canadian dollar's strength appears to be backed by strong fundamentals. The Canadian economy is running quite well, and commodity prices are skyrocketing. Some danger is on the horizon, though. MG Forex warns that because Canada is heavily dependent on the US as an export market, the CAD could be hurt if Hurricane Katrina slows demand from the US. One could argue the opposite by saying that Canada stands to gain from meeting post-Hurricane Katrina reconstruction material needs such as lumber and steel. However, The Big Picture offers a hilarious caution to those who automatically swallow the notion that reconstruction is a net boost to the US economy.

Nvertheless, I'd wager that the other two commodity currencies--the Australian (AUD) and New Zealand (NZD) dollars--have more to gain against the US dollar at this point, especially after you factor in their higher O/N yields of 5.50 and 6.75% respectively. The loonie is rightly strong, but it's been wandering in overbought territory for quite some time now, particularly if you look at AUD/CAD and NZD/CAD cross-currency pairs.

Posted by Emmanuel |

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