Tuesday, June 5, 2007

Canadian Dollar: LIFTOFF!

Off to the Races: Canadian Dollar Hits 30-Year High
Over the last two years, SOC has been forecasting the Canadian dollar would eventually reach par value with its southern counterpart: the U.S. dollar. Despite several corrections along the way to its current value of US$0.93, the odds are still good that the loonie will once again hit that threshold this year.
So why does the Canadian dollar keep climbing in value? For the last few years, Canada has been home to bulging budget and trade surpluses, the biggest commodity boom since the 1970s, low interest rates and strong domestic consumption.
Been Down this Road Before
Since March, the Canadian dollar has been the best-performing currency in the world, gaining a whopping 10% against the U.S. dollar.
Since hitting a 125-year low five years ago, the loonie has surged 33%. Today, the loonie trades at its highest level since 1977. From 1971 until 1976, the loonie traded at par value or greater versus its largest trading partner, the United States.
In 1976, the election of the provincial separatist Parti Quebecois finally drew the curtains down on the Canadian dollar bull market. This election, coupled with a peak in natural resource prices in 1980, helped the Canadian dollar drop in value.
But Canada is Basking in the Sun in Mid-2007
Supported by its fourth-largest budget surplus in history and booming commodity prices, Canada is truly enjoying an economic renaissance this decade.
The government has recorded 10 consecutive budget surpluses. The latest surplus, at C$9.7 billion dollars (US$9.1 billion), is mainly attributed to soaring tax revenues, which comes at a time when the Harper Conservatives have increased spending.
Its Mostly About Oil
Including the oil sands, Canada has an estimated 179 billion barrels of oil, recoverable with state-of-the-art technologies.
After Saudi Arabia, Canada is home to the worlds second highest oil reserves. The Alberta oil sands are a major contributor to Canadas exports since 2002. Provided crude oil prices remain above US$40 per barrel, the bull market in the energy patch will continue for many years.
This projection is also reinforced by Canadas close proximity to the United States the worlds biggest energy consumer. As the U.S. seeks to reduce its dependence on foreign oil, particularly from the Middle East, Canada is indeed sitting in a geographic sweet spot with billions in recoverable reserves.
Even adjusted for tax cuts and spending increases, Canadas balance sheet looks solid with a budget surplus in an environment of generally rising budget deficits.
No other country in the G7 harbors a fiscal balance remotely resembling Canadas position. However, other countries, including Norway, the Gulf Arab states, Singapore, China, and Russia have surpluses greater than 1% of gross domestic product (GDP).
Now Its At Par, Now Its Not
Though I believe the Canadian dollar will break par value versus the beleaguered U.S. dollar over the next several months, I dont expect the loonie to trade above par for very long.
Right now, Canadas non-energy exports are in the midst of hemorrhaging. The manufacturing belt in Ontario and Quebec is suffering heavy job losses, mainly due to the expensive Canadian dollar. The Canadian economy, which derives less than 20% of its gross revenues from commodity exports, cannot support a strong currency indefinitely.
This is especially true if you compare Canada to other resource currencies such as Australia and South Africa which remain far less expensive versus the U.S. dollar. Also, foreign multinationals certainly have far less incentives to establish operations in a country where the effective cost base has increased over the last five years due a strong currency.
At some point, the Bank of Canada, which is forecast to hike lending rates again this summer, will be compelled to cut interest rates in order to rescue a growing contraction in manufacturing. Plus, any significant decline in energy prices or government legislation designed to block booming foreign corporate takeovers will halt the loonies ascent.

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