The epic fall of the Canadian dollar
The short Canadian dollar trend has not come to an end.
As West Texas crude was slammed down to $48 now, its correlation with the loonie surged.
The collapse of the Canadian dollar in the past month (and year!) has been nothing short of spectacular. After all, when friends in Dubai asked me whether it was time to exit the trade in mid-June 2015, I published a column in KT recommending fresh shorts at 1.22. The loonie is at 1.3050 as I write. This strategy was vindicated with a vengeance after the Bank of Canada cut its policy rate to 0.5 per cent, slashed its growth forecast (Ottawa admits Canada is in technical recession!). The credit rating agencies downgraded Ontario and the Parliamentary Budget watchdog dissed provincial debt loads as unsustainable.
The real reason for my loonie bearishness was my conviction that West Texas crude was a no brainer short at $61 in mid-June. As West Texas crude was slammed down to $48 now, its correlation with the loonie surged. Canada trades as a classic "petrocurrency" when oil tanks, China slows and the Fed whispers tight money sweet nothings to Wall Street. Governor Poloz has also made it clear that he is desperate to stimulate exports via a lower loonie even as oil/mining capex financial distress sweeps Alberta, Manitoba and Saskatchewan. Relative economies growth rates and government bond yield spreads suggest the Canadian dollar has more downside. West Texas could be trading at $38 when the Yellen Fed finally tightens and the world realises that the Chinese Politburo's seven per cent GDP growth target is the biggest global joke since Chairman Mao's Little Red Book. The "surprise factor" in US economic data momentum is also loonie negative. Even though the Canadian dollar has fallen to six-year lows and the Relative Strength Index, or RSI, is at 75 above 1.30, this is not the bottom.
Provincial debt and a centre-left government in Alberta also suggest a higher risk premium on Canadian dollar assets while the Black Death in global commodities means no "merger mania" capital inflows from offshore strategic buyers (eg, China) or reserve diversification demand from petrocurrency recycling central banks in the Arabian Gulf, Mexico, Russia or Norway. Money market rates forecast a 30 per cent probability of another policy rate cut to 0.25 per cent in the next year. This means the loonie is skating on thin ice in Planet Forex's Cirque de Soleil. Countertrend rallies will be tested at 10-day moving averages near 1.2840 but my strategic target for the loonie must now fall to 1.36 by the end of 2015. Short term, yes, the RSI is overbought at 75 but remember loonie RSI was 86 back in January, when Poloz stunned the world with a shock rate cut. This was my biggest macro idea in summer 2014 and I am honoured to have shared this macro idea with my valued readers and friends at KT.
The spectacular fall of the Canadian dollar once again proves that the "trend is your friend" - until the trend comes to an end. The short Canadian dollar trend has not come to an end as I prepare to fly to Montreal via the Ville Lumiere to drop the Dauphin off at La Citadel.
This has been an "annus horribilis" for the world's petrocurrencies, led by the Norwegian kroner, Russian rouble, Malaysian ringgit, Nigerian naira and the Mexican peso. Petrocurrencies are difficult to trade since their correlations to oil price fluctuations vary so much.
The GCC currencies are pegged to the US dollar and are not petrocurrencies, though the burden of adjustment to an oil shock falls on the asset markets, a macro double-whammy. The British pound is no longer a petrocurrency since North Sea oil output peaked in the 1990s. The Russian rouble is leprosy due to the Kremlin's wars in Crimea/Ukraine, energy and banking sanctions. The Norwegian kroner's fate is influenced by the colossi sovereign wealth fund in Oslo. The Malaysian ringgit is influenced by oil, LNG, tin, rubber and palm oil.
The Canadian dollar's correlation to West Texas is estimated by econometricians at Wharton as 0.48. So a $55 fall in crude last summer meant a 28¢ hit to the loonie. This made total macro sense to me since crude oil is 25 per cent of Canadian exports, triple the ratio in the mid-1990s. The short Canada trade was a guaranteed money spinner after Saudi Arabia abandoned the role of the Opec "swing producer" at the last conclave in November.