Wednesday, 9 October 2013

Why the Loonie Fails to Fall

Ralph Shell, Excel Analyst

There was a time when the saying was "if the American economy came down with a cold, its neighbors would end up with pneumonia."  Currently, the US economy may not be afflicted but some early signs - coughing, wheezing - seem to be present. In large part, this is a self-inflicted slow down caused specifically by actions failed to be undertaken in Washington. 

Excel Markets ECN Forex Broker - Demo Trading Account ContestNaturally, the markets are apprehensive.  The politicians knew there were unresolved issues, namely a budget disagreement and an approaching debt limit.  Instead of negotiating to seek a compromise, Washington has sought to irritate the maximum number of people.  National Parks are closed to visitors.  Barricades are put at parking spaces at Mt. Rushmore so tourists cannot pull over to take a picture.  In many situations, more labor is employed to keep the parks closed than is required to keep them open.  Truly, we have government of the people by the government, for the government.

Then the blame game is played.  My brother is a retired US Air Force Officer with base privileges near his home.  There, the base commissary was closed but the base golf course and liquor store were open because of the shutdown. Go figure.

It goes on.  Eighty three per cent of government workers are still on the job, but they still cannot publish the COT futures and option report from last week.  Further, they will get paid for these days off doing nothing once the budget is resolved.

With the shutdown now in the second week, it is starting to take it's toll.  The US stock market is on the defensive, there is talk about a default of debt payment on US treasuries, and there are whispers this month's Social Security payments may not go out on time.  Should that happen, the noise levels will increase...

For the loonie, it seems to be successfully navigating through these troubled times. The currency has been confronted with some bearish news and shrugged it off.   For example, with 75% of Canada's exports destined for the US, this is a worry for many analysts, but so far the trade has continued uninterrupted.  Monday it was reported building permit issues were down 21.2% from July, bigger than expected, but the market failed to break.   

Stats Canada also reported a trade deficit today of C$1.31B.  This current deficit is the 20th in a row and would be a concern were there not investment money flowing into Canada. 

Commodity and crude prices, in particular, may be another consequence of the US shut down.  The perception that the US will slow down and reduce the demand for oil has put pressure on the cash price of crude, Canada's biggest export.  Tuesday afternoon, Western Canada Select was trading at $72.43, or about a $33.75 per barrel discount to WTI.  Crude is Canada's biggest export earner.  The current discount to WTI, however, is extreme and will negatively impact balance of payments going forward should it remain this severe.

Perhaps the combination of the shutdown, the trade deficit, and the dreadful price of Western Canadian Select is finally giving us a break, but how far will it carry?

The longer term outlook for Canadian energy exports is bright but attention and controversy has been focused on the Alberta oil sands projects.  For those geographically impaired, try to imagine moving billions of barrels of heavy dirty oil thousands of miles to where the refiners and consumer for this oil reside.  Canadian energy, though, is more than just Alberta.

Next door is British Columbia, a huge province - 365,000 square miles, compared to a mere 269,000 miles in Texas.  BC sits on massive energy supplies, mostly natural gas, which as gas is worth near nothing in North America, but in Asia as LNG, it is worth a wealthy future.

In May 2013, the Liberal Christy Clark ran for Premier and was re-elected on a pro-development agenda.  A large segment of the business is going to be the exportation of LNG.  It was reported in the Financial Post:

"Rich Coleman, head of a new super ministry to promote natural gas development in the province, said Monday the government of Liberal Christy Clark is on the verge of finalizing fiscal terms for LNG operators, will follow up with legislation early in the New Year to ensure long-term fiscal stability and anticipates the first major investment decisions to build LNG projects on the northern Coast in the third to fourth quarter of 2014......With 10 large players spending billions in the province to study the feasibility of LNG exports, Coleman said there is momentum behind the sector and anticipates many will go forward.

Malaysia’s announcement at the weekend during Prime Minister Stephen Harper’s visit that state-owned oil company Petronas plans to spend $36-billion on LNG in British Columbia “may put to bed some of the comments that … we are chasing a pipe dream,” he said."

So how do you trade the USDCAD?

Click to Enlarge USDCAD Daily Forex Chart
Well, we know in the present atmosphere there is bound to be some volatility as the politicians position and ploy.  It also seems there has been a lot of froth in these markets, perhaps some bubbles that will be popped.  If there is an equity shake-out, how will the USD fair, compared to the CAD?  This perhaps might be a risk, and an opportunity.

Click to Enlarge USDCAD Weekly Forex Chart
The COT Report no-show aside, we still get some useful daily stats from the CME.  These show a very small open interest in the CAD.  A pick-up in the price and the OI would be bullish. 

My preference in the CAD is to buy the dips, 1.0420 or better.  There may be some short-term pain but there is a good chance of longer term gain.
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