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Another Chance to Buy at Bargain Prices

Did you miss the Canadian dollar’s bottom back in January?

If so, you’ll probably get another opportunity to buy Canadian stocks at a lower exchange rate, even if the loonie has already put in its ultimate low.

Foreign-exchange analysts expect the currency to come under significant pressure in June because C$45 billion of Canadian dollar-denominated bonds are maturing, and odds are that foreign holders won’t be in a hurry to reinvest in Canada.

“The trend in recent years has been for less-than-full reinvestment–at least immediately–and a large monthly capital outflow,” Adam Cole, head of FX strategy at RBC Capital Markets, told the Financial Post.

Meanwhile, famed strategist David Rosenberg told clients that the Canadian dollar is currently treading “dangerous waters,” due to a possible raft of weak economic data.

At the same time, we should probably take a moment to enjoy the Canadian dollar’s recent rally. As longtime U.S. investors in Canadian stocks, we’ve watched the tailwind from a rising loonie turn into a major headwind. And that’s not only eroded the value of our holdings, it’s also clipped our dividends.

During the global commodities boom, the Canadian dollar peaked at US$1.06 back in July 2011. It then traded near parity with the greenback through mid-2014, until a hawkish U.S. Federal Reserve and crashing crude oil prices drove the loonie just below US$0.69 in January.

Since then, the Canadian dollar has enjoyed one of the strongest rallies among global currencies, rising more than 16%, to just shy of US$0.80. The loonie has since backed off a bit and currently trades near US$0.77.

One of the most frequently asked questions at our Wealth Society’s annual investing summit earlier this month was when the Canadian dollar might be back at parity with the U.S. dollar.

Right now, there are three factors driving the country’s exchange rate.

The first is the divergence in monetary policy between the Fed and the Bank of Canada (BoC). While the U.S. central bank is nominally in rate-hiking mode, the BoC is holding its benchmark overnight rate at 0.5%, its lowest level since the downturn.

And traders are currently betting that it will remain at that level at least through the year’s end, especially given the hit to near-term growth from the wildfires in Alberta. The BoC estimates that the disaster will cut 1.25 percentage points from second-quarter gross domestic product growth.

By contrast, the Fed is expected to hike short-term rates at least once this year, which would bring its benchmark federal funds rate to a range between 0.5% and 0.75%.

When such differences in rates arise, traders will go wherever they can earn the highest yields, thus causing selling pressure for one currency, while giving a boost to the other.

The second factor is volatile energy prices, with crude oil commanding the most attention. The Canadian dollar has been highly correlated to oil prices in recent months, and the strong rally in crude has been a big part of the loonie’s upward momentum.

While the wildfires in Canada will weigh on the country’s economic growth in the near term, the disaster has also taken significant crude production off line, which has helped to reduce the glut of supply.

Of course, higher oil prices will likely compel producers to ramp up production again, which could then add to the glut.

The third factor is closely tied to the first two: the health of the Canadian economy. Gross domestic product isn’t forecast to rise to 2.5% on an annual basis–the threshold that indicates the economy is firing on all cylinders–at least through 2018.

A lower exchange rate will help other sectors of the economy pick up some of the slack left by the oil-and-gas sector, but odds are it will take another global commodities boom to restore the Canadian economy to its former glory, while pushing the loonie back to parity with the greenback.

But for those U.S. investors who have yet to diversify into Canada, the lower exchange rate makes for an enticing long-term investment opportunity.

Eventually, there will be another commodities boom. When that happens, the tailwind from a rising loonie will enhance portfolio gains, while further compounding income from dividends. That’s a win-win situation.

Even with the loonie’s recent ascent, from a long-term perspective, the currency still offers a compelling value: It trades about 6% below its 20-year average. And if the Canadian dollar takes a dive in June, it will be time to back up the truck and load up on Canadian Edge’s Dividend Champions.


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Stock Talk

Patrick Cerra

Patrick Cerra

When can we expect this in June. What is the maturation date of the June Bonds? Is it always the end of the month?

Thanks,
-Pat

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