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Loonie – Opportunity of the year?

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Did you know that large parts of Canada have less gravity than the rest of planet earth? Sadly, this random fact does not apply to the country’s currency over the past three years. If anything it feels like there’s more, not less gravity on the Loonie than any other G7 currency in the world. Yet, if you are opportunistic, Sanostro believes the Canadian dollar is one of the most attractive buying opportunities out there…

Take a quick look at the not so pretty fundamentals. Energy contributes about 40 per cent of Canada’s GDP. The country has the third largest oil reserves in the world. Naturally, when energy prices sold off dramatically, it took a huge bite out of the country’s budget revenues. Bearish investors will point out that the Bank of Canada assumes crude to average 36 USD per barrel in its near term monetary policy outlook. That’s pretty optimistic, considering where we are now, especially now that Iran is back in the game. The BoC might have to revise that forecast. On top of this, non-energy exports have yet to show material gains despite the steep fall of the CAD. Given the drop in energy prices and the country’s profound reliance on the sector, the outlook for capital investment is looking rather dire. 

Put aside the fundamentals and bearish talk for a second. Recent tentative agreements by oil producing nations to freeze oil output at current levels and declining US shale output both hint that fundamentals might become more attractive. The Bank of Canada projects that Canada’s economy will grow about 1.4 per cent this year, and 2 per cent next year. In other words, it believes the economy will grow, not shrink. The country’s 1.2 trillion USD in debt represent 84 per cent the GDP, which compares to about 19 trillion USD, 108 per cent of the GDP of the US. Investments in Canada might get a boost as the access to a great talent pool (Canada is the world’s most educated country, as half its residents have college degrees) and a lower currency join hands. For instance, you could start to see more M&A activity as – on a currency adjusted basis – Canadian companies become cheaper to buy. If you believe in a rebound of oil, this is – risk adjusted – an interesting way to play it. 

The last time the CAD bottomed-out, you needed a great deal of patience, the right “gut- feeling” and a good portion of luck to time your entry correctly. Interestingly enough, crude prices were – inflation adjusted – between 30 and 35 USD then, precisely where they are now. But, owning oil physically is difficult and rolling costs are expensive. Buying oil-related equities is still a very risky game as small energy related companies continue to file for bankruptcy and many might not be able to finance themselves till the cycle returns. So how do you make sense of all this and put on a trade? 

Our signals identify when a market is shifting from a normal to a crisis environment. The aim is generally on reducing the drawdown, but the models can also be a great tool for timing entries. Right now, we recommend to stay put with the overlays in place and jump in when our signals (which have been bearish on the CAD since the parity with the USD) turn positive. This way, fundamentals and momentum, not the laws of gravity, will be on your side.

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