Smart Trade Digest
August 2007

I woke up this morning to a nice surprise. After a few months of battling for pips in an unstable, volatile and often irrational market I arose to some really nice trades in my account. I mean really nice. Thank God (or whomever else is in charge here) because I have taken my fair share of beatings lately. Actually I think I took a portion of your share as well. So, this morning’s turn of events was very pleasing.

It did get me thinking about the USD again. I tend to fluctuate between being a pure chartist and being a news junkie. Since the beatings started I have swung back to the technicals, relying on the charts to pull me out of my misery.

Take a look at today’s EURUSD 1 hour chart…

The market moved over 150 pips in a matter of a couple of hours this morning (August 9, 2007) continuing the high market volatility that we have seen lately.

… talk about volatility, and the markets show no sign of mellowing out. Someone famous somewhere said “market volatility begets market volatility and market calm follows market calm”. That certainly seems to be the case.

The USD has had a rough ride lately and there is some dissention between experts and analysts regarding what to do about it. One of the biggest drivers of the volatility in the US markets has been the turmoil in the equity and credit markets. As I get back in touch with my newsy-self I am being deluged by stories about the reversal of the boom in the sub-prime mortgage lending, private equity and other risky sectors.

If you have been lurking around the trading markets for a while you have probably heard the term “Greenspan put”. This term denotes the assurance that the Fed would cut interest rates to halt any big fall in the markets. With Greenspan happily sitting on a beach sipping a Mai Thai (not really), traders have had to learn to adjust to Ben Bernanke, who is facing his first big challenges in his term as Chairman of the US Fed. In fact, the measured tone of this week’s Fed policy statement quashed the hopes some traders were harboring for a “Bernanke put”. The report agrees that “financial markets have been volatile” and that “credit conditions have become tighter for some households and businesses”. It also admits that “the downside risks to growth have increased somewhat” However, it also states “predominant policy concern remains the risk that inflation will fail to moderate as expected” and concludes by leaving the interest rates unchanged.

Everyone has an opinion when it comes to the economy. One option is being touted by US housing agencies and even two Democratic senators. They have been petitioning for an easing of portfolio limits to inject liquidity into the troubled mortgage markets. Some investors had their hopes pinned firmly on the idea of the Fannie Mae and Freddie Mac swooping in like Superman to provide relief to the beleaguered markets. However, President George W Bush played down the idea of giving them a larger role in efforts to stabilize the troubled US mortgage market and expressed confidence that financial markets are functioning well in spite of bouts of volatility.

I think that if there is a real danger of crisis then the Fed will respond in an aggressive fashion, offering liquidity support and the prospect of rate cuts. Some economists are convinced that the Feds need to cut rates and the sooner the better. High Frequency Economics’ chief US economist Ian Shepherdson has been quoted as stating, “… the key point is that the glory years for the US economy and equities are over, at least until consumers’ finances are restored to equilibrium.” Shepherdson continues, “Eventually, the Fed will have to respond by cutting rates and holding them for an extended period at lower levels – probably less than 4 per cent. That will not reinflate the housing bubble, but it will limit the pain elsewhere in the economy.”

In all honesty I think that the overstretched American consumer is the real issue and doesn’t look like it will be disappearing any time soon. In the mean time I will cross my fingers and do all the superstitions rituals that it takes to continue to wake up to mornings like this one.

Share Magazine
August 2007

Looking at the currencies of the world is an interesting view from where I sit, economically speaking. This month I am turning my chair to face due north. Our friends to the North continue to enjoy records highs as their economy keeps growing and growing. Is it any wonder that Canada has much to celebrate right now; the Loonie turning 20 this year and the Canadian economy soaring to new heights as its dollar reached a near three-decade high in June.

Canada’s currency is the strongest it has been since May 1977 and is trading closely with the U.S. dollar. To give some perceptive on this front – the last time the Canadian dollar was on par with the U.S. dollar was November 1976, the same month Jimmy Carter was elected U.S. president.

The Canadian economy has been bolstered by a number of factors; a recent run of strong data, high commodity prices and continued merger and acquisition interest in Canadian firms.

Economic Data

Economic Data always has a significant influence on currency prices. I think that inflation will be a concern for the Bank of Canada. Like many experts, I also think that the Canadian dollar is going to continue to gain ground. Core inflation, the measure central bankers monitor most closely because it excludes volatile goods such as gasoline, has been above the bank’s target for nine straight months, including a 2.2 percent gain in May. Consumer prices have increased by more than 2 percent for three straight months.

Kamal Sharma, a currency strategist at Bank of America, has been quoted stating, “There has been a batch of much stronger than expected data and there’s a view that the Bank of Canada is turning more hawkish.”

The Bank of Canada is widely expected to lift interest rates later this year. Bank of Canada governor David Dodge made the comments in a speech to the Board of Trade in St. John’s, Nfld., while also dropping more hints of a possible interest rate hike next month – a move that would likely drive the Canadian Dollar even higher against its U.S. counterpart. Many economists are forecasting parity with the U.S. greenback by year’s end, citing expectations of an interest-rate hike in July.

Speaking in the Atlantic province of Newfoundland and Labrador, Bank of Canada Governor David Dodge admitted the Canadian dollar had risen further and faster than the central bank had expected.

Commodities

Another factor fueling the Loonie’s climb against the dollar are rising commodity prices, in particular high energy prices. Economic growth in Canada has been “broad-based” and the jobless rate has fallen to a 33-year low of 6.1 percent because of the boom in demand for the country’s commodities such as crude oil and copper.

Canada is a major oil exporter and it’s dollar often moves in line with the commodity. As expected strong commodity prices tend to give the Canadian dollar a lift. With London Brent crude hitting a fresh 11-month high and US crude well above $72 it is no wonder the Loonie is getting so much support, and there isn’t an end in sight. The International Energy Agency has said that oil demand will grow more quickly in 2008 than in 2007, boosting the need for OPEC crude.

The price of oil increased from about $61.60 to $63.13, or about 2.5%, over the early March to mid-May period. As is so often the case, the price of natural gas followed along, increasing by a whopping 8.6% over the same period. Gold was up about 3%. Although less influential, copper, nickel, and uranium were up by about 30%. There is no doubt, therefore, that an increase in commodity prices, particularly natural gas, has been a major contributor explaining why the Canadian dollar increased a full 7.4% against the US Dollar between early March and mid-May, rather than the roughly 3.0% of the other major currencies.

Mergers and Acquisitions

The Canadian Dollar has been bolstered even more by a battery of foreign takeovers of and investments into Canadin companies over the past year, one of the most recent being Rio Tinto’s $38.1 billion cash offer for Alcan Inc. This recent activity looks only to help sustain the currency trend. Shaun Osborne, chief currency strategist at TD Securities recently stated, “Generally, a weak (US) dollar, strong commodities, and very significant merger and acquisition inflows suggest the Canadian dollar is unlikely to weaken significantly in the short term.”

The Dollar’s Slide

The US Dollar weakness has also helped to strengthen the Canadians position. The USD’s slide has come amid negative market movements that have been driven in part by the continuing bad news from the US sub prime housing market. Rising interest rates and economic slowdown here in the US have lead to more defaults in subprime mortgages, loans to borrowers with weak or spotty credit histories.

In the United States, the housing bust is turning out to be deeper and more prolonged than earlier thought. As evidence of this softening, three-month T-bills in the United States have fallen from 5.21% in early March 2007 to 4.63% in mid-May.

Between early March and mid-May 2007, a depreciation of the U.S. dollar was clearly a significant contributor to the 7.4% appreciation of the Canadian dollar, from 84.7 cents to 91.0 cents.

The Bright Side

A strong Canadian currency isn’t all bad news. It is also considered good news for the United States. A competitive Canadian dollar and cheaper gas prices across the border are making car vacations to the United States more appealing for Canadians.

Michael Middelaer, director for the B.C. Automobile Association’s (BCAA) travel branch, said his office has experienced a double-digit percentage increase in inquires by Canadian travelers to the U.S. “People are planning road trips to the U.S. in greater numbers than we’ve seen for a long, long time. We recognized there’s a major shift going on.”

The Canadian dollar, which last June was worth 89 cents against its U.S. counterpart, is now trading at 95 cents, making trips to the U.S. more affordable. And while gas prices in the U.S. have risen significantly, they are still on average 25 percent lower than what consumers pay at Canadian pumps.

Shopping malls along the U.S. border are also packed with Canadian shoppers. Bethany Lyons, clothing manager at Target, said at least half of the cars in the mall parking lot have Canadian license plates and the store has noticed an increase in Canadian customers during the past two months.

Cara Buckingham, marketing manager for Bellis Fair mall in Bellingham, Washington, has seen an increase in Canadian traffic and believes the strength of the Canadian dollar has had a big impact on people’s decisions to travel south. At the Bellis Fair mall, retailers are seeing more Canadian shoppers – especially those that don’t have stores in Canada.

The Flip Side

Not to put a damper on a good thing but the strong Canadian dollar does have some down sides. Canada’s finance minister Jim Flaherty has said the strong currency was a challenge for manufacturers and their key to coping with it is to be more productive.

While Bank of Canada governor David Dodge must act to put a choke hold on inflation that’s largely being stoked by Alberta’s booming oil-patch economy, economists say higher interests rates and an emboldened Loonie will create a double-edged sword for the economy. A higher dollar makes imports cheaper for shoppers, but it also deals a blow to Ontario’s struggling manufacturing sector by driving up the cost of exports. That in turn could lead to more layoffs and eventually hurt consumer spending.

What has many Canadian financial experts worried is the concerns about inflation and squeezing exporters. Canada’s dollar has risen from a record low of 61.76 U.S. cents on Jan. 21, 2002, when oil was about $18 a barrel. Commodities including oil make up about half of Canada’s exports. The currency’s 9.4 percent rally this year is squeezing exporters’ profits, prompting provincial finance ministers to argue against rate increases.

Exporters are being hurt by the currency’s rally, which erodes the value of sales in U.S. dollars. Vancouver-based Canfor Corp., North America’s fourth largest lumber producer by market value, posted a first quarter loss of C$42.7 million. The company derives about 85 percent of sales from U.S. dollars.

Canada’s high dollar and slowing U.S. growth have weighed on the economy, mainly because of the effects on exports. Canada sends more than 80 percent of its exports to the U.S., including lumber and other building supplies.

The manufacturing sector has complained that the strong dollar makes it hard for firms to compete abroad. Government officials admit that this is true, but say it also lowers the cost of machinery and raw materials, which businesses need to be competitive. According to the Canadian Manufactures and Exporters, the country’s largest trade and industry association, the sector employs 2.2 million people directly and another 2.5 million depend on that sector for their livelihood.

Jay Myers, chief economist for the Canadian Manufactures and Exporters, looks to Germany for inspiration. Like Ontario and Quebec, manufacturing is central to the economy, and Germany too, as been dealing with a strong currency. Yet manufacturing is surging ahead there, driving strong economic growth through exports of goods to Asia.

Today, the driving growth in the Canadian Economy has been the construction industry, along with non-residential construction and engineering work.

Conclusion

Canada’s top banker offered his two cents on the high-flying loonie the other day, suggesting the currency’s reaction to high commodity prices and increased demand for Canadian goods has been stronger than could be expected – at least based on past experience. “The Canadian economy has adjusted and is continuing to adjust to take advantage of our opportunities in an integrated global economy,” said Tiff Macklem, deputy governor at the Bank of Canada.

A survey of Canadian investment managers found that over 50 percent are now bullish on the currency, more than double the 25 percent just three months ago. The latest quarterly poll of Canadian investment mangers early this month by Russell Investments Canada found that managers are also bullish on Canadian stocks.

The majority of Canadian investment managers surveyed has high expectations for the Canadian dollar, believe the Canadian equity market is fairly valued and are generally bullish on equities. Overall, 68 percent of managers believe the Canadian equity market is fairly valued.

I agree that the Canadian market is fairly valued and that such a strong Canadian dollar bodes well for traders. The Canadian rise has caused many financial experts to take note and watch. With such a dynamic year, I think more and more traders will be paying closer attention to the Loonie – and the trend is likely to continue.