Thursday

The Loonie Has Been Appreciating Lately But Will This Trend Continue?

Tom Cleveland from Forex Traders examines the Loonie and its price trends during the first quarter of 2012 below:

The Canadian Dollar has appreciated modestly in recent months versus the Greenback.  The Loonie has traditionally correlated quite tightly with global oil prices, and, with Iran threatening to cutback shipments, tensions have risen, as has the price of a barrel of crude.  Coupled with the tentative agreement in Europe to support Greece with a bridge loan and favorable economic data in the United States, the basic fundamentals that drive currency valuations have been favorable for Canada.

A single quarter, however, does not necessarily signal that good times are here to stay.  There is still a healthy dose of uncertainty in today’s financial markets, but, for now, the picture has a “glow” about it, as depicted in the diagram below:

Predicting currency values with accuracy is an extremely difficult task, especially when uncertainty is in the air.  In 2011, for example, foreign exchange hedge funds had one of their most trying years.  Many funds barely broke even, and some of the larger funds posted losses for the year.  Volatility can fuel a speculative market, but too much of it can destroy even the best-conceived strategies.  To gain insights on where the Loonie might go in the near term, analysts would typically review a host of related data, as posted above, for influencing factors.

Exchange-Traded Funds (“ETFs”) offer an excellent way to check for significant correlations.  Returns for the Canadian Dollar, Oil, Gold, the Euro, and the S&P 500 index are presented.  Quotes for the “USD CAD” currency pair have been inverted such that the related ETF (“FXC”) values reflect positive gains for the “CAD”.  A few insights are as follows:

• Over the past three months, the Canadian Dollar, represented by the “Blue” line in the chart, has strengthened nearly 5% versus the Greenback;

• The path for the Loonie actually equates roughly to a simple moving average for the pricing behavior of Oil, the “Green” line, over the same period.  Currencies tend to be less volatile that commodities or stocks;

• As the European debt crisis moved toward its present version of a resolution, the Loonie and Euro tracked very similar paths, reflecting how interconnected our economies are in this new era of globalization;

• The demand for Gold is often a “proxy” for the status of global tensions in the world.  When Iran threatened to curtail oil shipments to Europe, Gold suddenly appreciated, even more quickly than the price of oil;

• A continuing flow of favorable economic data from the United States has boosted stock values to their highest levels in four years.  Since the U.S. buys nearly 80% of Canadian exports, increased economic activity south of the border can only auger well for Canadian near-term prospects.

Should investors lean towards the Loonie?  Parity with the U.S. Dollar was reached in February and has hovered there for the past few weeks.  Many analysts believe the Canadian Dollar is poised to move higher, but this forecast assumes that the global economy continues to move towards recovery and that the European “deal” on the table is actually implemented without a hitch.

Any type of political turmoil in the Middle East, or anywhere else for that matter, might also reverse these positive outlooks.  Any “shock” of this type could send capital scurrying to “safe havens”, typically U.S. Treasuries and precious metals, and thereby drive the Loonie to lower levels as happened in 2008.

For the time being, however, this good news has been encouraging.  Optimism is nice for a change, but caution may still be the watchword of choice for the months ahead.