Rise in Canadian dollar shows break with U.S. economy

By Haris Anwar
Bloomberg News Service
Monday, September 17, 2007

http://quote.bloomberg.com/apps/news?pid=20601087&sid=a6uPcUFdLnao

TORONTO -- Currency traders are concluding that there's nothing the U.S. economy can do that Canada's can't do better. Much better.

The U.S. and Canadian dollars, which traded in tandem 94 percent of the time since 2000, decoupled in May and now have diverged for the longest stretch this decade, according to data compiled by Bloomberg.

While the worst housing slump in 16 years threatens to slow U.S. growth, record oil prices and rising costs for copper and zinc are boosting Canada's exports and allowing the government to balance its budget. Energy accounted for 19 percent of Canada's exports this year, compared with 12 percent in 2002, government data shows.

"Canada is in a very strong position," said John Taylor, chairman of New York-based FX Concepts Inc., which manages $12.1 billion in currencies. "Its economy has significantly diverged from the U.S., and it's got all those things the world needs. My longer-term bias is that the Canadian dollar would be stronger than the dollar."

Canada's currency, nicknamed the loonie after the image of the national bird on the one-dollar coin, has risen 3.7 percent against its U.S. counterpart since June 12 amid growing speculation that losses related to U.S. subprime mortgages would prompt the Federal Reserve to cut interest rates.

Of the 16 most traded currencies, none has done better than the loonie this year. It gained 13 percent, climbing to a 30-year high of 97.30 U.S. cents on Sept. 14. The currency rebounded from a low of 61.80 cents in January 2002.

Futures show hedge funds and large speculators are raising bets that the Canadian dollar will extend its gains. Investors held a net 58,754 contracts on a rise in the currency as of Sept. 11 on the Chicago Mercantile Exchange, up 14 percent from the prior week, according to the Washington-based Commodity Futures Trading Commission.

The U.S. and Canadian dollars rose and fell against the euro in similar patterns 94 percent of the time since the introduction of Europe's single currency in 1999 until May. The Canadian dollar has mirrored the euro's gains against the U.S. for more than three months.

The currency climbed 2.4 percent last week amid speculation in the futures markets that Bank of Canada Governor David Dodge will hold the key lending rate at 4.5 percent this year, while the U.S. Federal Reserve cuts its target for overnight loans between banks from 5.25 percent.

Two-year Canadian bonds yield more than Treasuries for the first time since 2004, adding to the currency's appeal.

Canada can't escape a slowdown in the U.S., said David Mozina, senior currency strategist at Lehman Brothers Holdings Inc. in New York, the world's fourth biggest securities firm by market value. He recommends selling the Canadian dollar against the Norwegian krone, the Japanese yen and the Swiss franc.

"It's a matter of time before the negative events spill over the border," said Mozina. "The monetary policy is joined at the hip. It's a matter of time when people start penciling in a rate cut by the Bank of Canada.''

In the meantime, rising prices of oil, copper and gold are fueling Canada's economy and reducing its reliance on U.S. manufacturers. The oil sands in Alberta contain the largest crude deposits outside the Middle East, and Canada is the world's No. 2 producer of nickel and zinc.

Oil trades at $80 a barrel compared with about $30 at the beginning of 2003, while gold has doubled to more than $700 an ounce. Zinc prices have soared over the same period to about $3,000 a ton from $750. Copper for delivery in three months costs about $7,500 a ton, compared with $1,600 four years ago.

Auto-part exports mainly to Detroit-based General Motors Corp., Dearborn, Michigan-based Ford Motor Co. and Chrysler LLC of Auburn Hills, Michigan, accounted for 17 percent of Canadian exports, down from 26 percent in 2000.

Canada's economy is set to expand 2.5 percent this year, outperforming the U.S. for the first time in five years, according to a Bloomberg survey this month.

"Canada is a current-account surplus country. Its fundamentals are sound," said Samarjit Shankar, director of global strategy for the global markets group in Boston at Bank of New York Mellon, the world's largest custodian bank, with more than $20 trillion in assets under administration. "Global investors are not cutting and running from their Canadian exposure. That suggests that the Canadian dollar should remain well-supported."

Shankar predicts that the loonie will achieve parity with the U.S. dollar early next year.

Rising tax revenue and energy royalties have allowed the Canadian government to post 10 straight budget surpluses, the only country among the Group of Eight nations with a balanced account. Canada's total consolidated revenue rose 25 percent during the past five years to C$601.26 billion.

The government has used the excess to pay down about C$90 billion in debt over the past decade. The U.S. had a budget deficit of $318.6 billion last year.

"The Canadian dollar has held up much better than many other currencies," said Eric Takaha, who helps manage about $160 billion at Franklin Resources Inc. in San Mateo, California. "We've been constructive on the Canadian dollar, and will hold on to our long position."

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