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Friday July 24, 2009 - 12:46:05 GMT
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To Be, Or Not To Be … In Canadian Dollars?

Key News
• German Business Confidence Rises as European Economy Moves Toward Recovery (Bloomberg)
• U.K. Economy Contracted 0.8% in Second Quarter, More Than Double Forecast (Bloomberg)
• Tightening Credit Becomes Bernanke Bind as Fed Faces Bond Purchase Unwind (Bloomberg)
• Asian markets cheered by US rally; Positive earnings drive Dow to 9,000 (Financial Times)

“When any part of the financial system is constrained from taking on risk, the market simply evades these constraints in one of three ways: It innovates around them, it generates or develops new and unregulated parts of the financial system, or it conceals regulatory violations.”

       Michael Pettis

FX Trading – To Be, Or Not To Be … In Canadian Dollars?

As Jack mentioned on Tuesday, we’re in Vancouver speaking at an investment conference. A popular question here, as the case with most conferences and seminars we attend, is:

Which currencies would you want to hold right now for long-term appreciation if you didn’t want to have all your money in US dollars?

To us, based on our current long-term global macro analysis, the answer is not clear. Why? Well because we seem to be at a very important junction; generally speaking, a junction that could lead currencies in one of two directions versus the US dollar – up ... or down.

Based on the inherent risks we still believe to be dispersed throughout the global financial system, it doesn’t make much sense to us to move much money into any currency outside of the US dollar.

(Chart unavailable in text format.)

Of course, this could change. And it could change quickly.

I talked about the S&P 500 on Wednesday – it was trading just below a key resistance level. Considering the sharp move up to that level in the days prior, I thought stocks may have needed a rest. That rest lasted for about two days. Then yesterday there was a breakout move.

The chart above shows the S&P breakout move that’s following through on its substantial rally since March. The chart below is also a daily chart, but it pulls back to a wider time frame to show how much room there is for the S&P to potentially climb. If things play out this way and stocks keep climbing then we likely see similar moves in the currencies.

 (Chart unavailable in text format.)

If the currencies do confirm the breakout in stocks it could mean a major capitulation to risk-taking. It doesn’t have to mean that, but it could become a self-fulfilling move begetting more confidence and more buyers.

Do note that even though stocks surged yesterday, they ran into trouble at the close of the session on worse than expected earnings results out of some key companies. After hours trading saw the S&P sink and erase half of the day’s monster gains. Today stock futures are trying to fight back to yesterday’s intraday highs.

Ok, back to the long-term currency holdings ...

If risk-appetite returns and recovery potential grows, then it’s possible the US dollar is thrown into the fire ... yet again. And at that point it will make sense to move some long-term money into other currencies.

So which other currencies? If global trade is expected to eventually return to “normal” then positioning in a commodity currency may make sense as they would have little financial risk relative to some of the other major currencies.

A speaker here in Vancouver called the Norwegian krone the most attractive currency in the world. While they do have decent fundamentals and potential when the global economy is in working order, I still wouldn’t necessarily go out on that limb. Keep your eye on the krone if you’d like. But to pay some respect to our hosts this week, let’s take a look at the merits of the Canadian dollar ... a major currency with similar fundamental dynamics as the krone.

In just the last weeks there’s been an optimistic tone struck on Canada. The Canadian dollar has not been shy about it either. After clearly pulling back when most other currencies went range-bound, the Loonie has pretty much gained back all the ground it gave up to the buck.

 (Chart unavailable in text format.)

This week we learned that Canadian retail sales increased by larger than had been expected. This is always an optimistic sign as it potentially shows a revival in the consumer and a step towards growth.

Similarly, Canadian imports have increased in volume, indicating that the domestic sector may be on the mend. What’s more, the real estate market in Canada has recovered somewhat – existing home sales jumped 31.5% between the first and second quarter of this year. I’m sure some Canadians will tell you the real estate market is far from out of the woods, but perhaps a majority of the pain has passed.

There’s also been notable strength in the services sector of the economy ... at a time when manufacturing is still slumping. This conveys the important distinction between domestic spending versus foreign spending on Canada’s exports.

The financial services sector in Canada isn’t half bad, either. Canada’s banks have not tip-toed the edge of the abyss ... or gone over the edge like many competing banks in the US and Europe. Are Canada’s financial institutions operating under ideal economic conditions? Absolutely not – the economy in Canada and globally is still soft, yet the industry has remained stable.

Until investors and economists gain a sense of conviction that recovery is imminent, there could still be a lot of question marks for Canada. The Bank of Canada yesterday did some work at cultivating some conviction. In their monetary policy report they noted that Canada is coming out of recession in the third quarter of 2009. Growth estimates were revised upwards as well.

The Bank of Canada’s chief Mark Carney made note, though, on the USDCAD exchange rate. The central bank’s growth revisions revolved around expectations of USDCAD at $1.15. The Canadian dollar is stronger now (USDCAD $1.085) than it was at the beginning of the month (USDCAD $1.16). With that in mind, central bank intervention is on the table. If recovery doesn’t set in earnestly then a strong Canadian dollar threatens to hamper progress.

So, in the relative game we play, there’s a lot to consider when choosing the least ugly in an ugly contest ... as so many casual observers like to quip. A friend of ours, a British Columbia local, had this to say regarding Canada, the loonie and Mr. Carney:

“We had the Greenspan Put - is this the Mark Carney CALL? <YOINK....> "Money for nothing and get your kicks in the groin for free..." - you could just see this coming ...”

Have a nice weekend.

John Ross Crooks III
Black Swan Capital LLC,


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