Monday, 11 August 2014

Canada and Italy - Two Contrasting Economies

Momentum players make their money buying new highs or selling new lows, hoping the markets are going to extend their recent moves.  For the pure technical analyst the price level is not relevant.  If there are enough players, price does not matter, only the momentum is relevant.

Over time, the cure for high prices is high prices, and for lows the opposite works.  High prices kill demand and low prices stimulate demand.  This theory works, the fundamental traders argue, but not very quickly.  Changes in supply and demand, because of price, may not occur for six months or possibly much longer.  For that reason it is important to have an understanding of the strength of the different market drivers.

In Canada, for example, there is a Bloomberg article touting the bearish side of the Canadian Dollar.  Because the C$ has weakened versus the USD, making a recent new low above 1.0960 to the USD, this is a good enough reason to forecast further weakness, according to the technicians.

It might be best to remind the C$ bears this move has been in large part the goal of Stephen Poloz, the replacement central Banker for Mark Carney.  Poloz wanted a lower loonie to stimulate export demand for the aging manufacturing sector in Ontario.  The currency has weakened, and recent reports show Canada may see a return of demand for manufactured cars and car parts.  Bloomberg reported:
The fifth straight monthly gain in domestic output adds to signs the economy is making progress on what Bank of Canada Governor Stephen Poloz said will be a two-year recovery toward full output. The central bank on July 16 estimated annualized growth of 2.5 percent in the April-to-June period after expansion slowed to a 1.2 percent pace in the first quarter.....and

Canada reported the largest merchandise trade surplus in more than two years in June as exports reached a record on gains in crude oil and metals.

The surplus was C$1.86 billion ($1.69 billion) in June, the widest since December 2011, Statistics Canada said today in Ottawa. Economists forecast the trade account would be balanced, according to the median of 17 forecasts in a Bloomberg News survey. The agency revised the May figure to a C$576 million surplus, from a C$152 million deficit.
The economic reports continue and the news is positive.  On Thursday the building permits M/M was +13.5% better than expected -1.3 , and the respected Ivy PMI was 54.1 compared to expected 53 and last months 46.9.  Some of this might be the results of Poloz's efforts to weaken the yen.  The Friday Canadian labor report was a disappointment.  Only 200 hundred people found new jobs, far less than the 20K forecast.

On balance, the economic numbers do not seem to warrant the beating the loonie has taken this week as it retreats toward the 1.10 handle.  Probably the weekly geopolitical events and the consequent acquisition of the USD hurt the C$ in comparison.

Still, despite the weakness, the Canadian economy and it's currency seem like sounder ownership, compared to the Italian, for example.  It was reported this week the Italian economy posted the second consecutive quarter of negative growth, the classical definition of a recession.  This means Italy has begun a triple recession with GDP to be roughly the same as it was in 2000.

The EU-, Bundesbank- and IMF-crafted recovery of reform and austerity, for Italy, as well as most of Europe, has failed. The total sovereign Italian debt is about €2.2T or about $2.9T.  Absence of growth, this means the ratio of debt to the GDP keeps growing.  The Italian debt to GDP ratio is 135% and will reach over 140 in 2015.  Worse still is the lack of inflation.  This means the debt must be paid back with a more valuable currency.  Or perhaps it will not be paid back at all.

Currently the Italian government has received a reprieve from the global central bankers.  They have made the money supply ample and the rates low.  The result is an Italian ten year bond which yields only 2.80%.  Obviously this makes the debt load easier for the government, but it seems there is risk for the bond owners.  Eventually the rate will go higher and the results will not be pretty.  There may be some buyers remorse amongst the many buyers who in the last year, searched the globe for yield and bought Italian bonds.

Youth unemployment in Italy in 2012 was about 28%.  In June 2014 it was 43.4%  Sadly, Italy is headed for a decade of youth that is bound for other countries to find employment.  Once established elsewhere will they really return to Italy to help pay off the debt?

If the Italian currency were independent, we could merely buy the  loonie and sell the lira, or its replacement.  Now, as the third largest economy in the EU, it is getting special attention from ECB President Draghi.  Italian reforms are being suggested by Frankfurt and Brussels to the cumbersome ineffective government in Rome.  The reform proposals for Greece failed.  Maybe the EU officials will get it better this time.

The question, then, is there a trade, buying the C$ and selling the euro?  One of the problems with this trade is the popularity of the short euro position.  In the futures market, the most recent COT report show the specs are now short 182.7K contracts, up from 157.2K last week.  Part of the short is politically inspired and could change quickly.

Click to Enlarge EURCAD Daily Currency Chart

The second reason I hesitate to open the trade is the technical picture.  On Friday, the EURCAD broke above the previous trading range.  Further, the pair traded above the 50-day SMA, closing at 1.47.  Perhaps the 200 SMA which is at 1.4828 will slow the move down, but the real resistance seems to be in the 1.49 area.

To summarize, the trade has appeal fundamentally, but the technicals suggest it is best to monitor carefully and wait for developments.

Click to Enlarge EURCAD Weekly Currency Chart

Ralph Shell, Excel Analyst
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