Forex Investment and Currency Trading

USD/CAD hit 1.3017 on October 28 its highest level since September 2004, not coincidently as oil prices fell to their lowest level since May 2007 near US$60/b. Oil prices have since bounced toward US$65/b and USD/CAD has retreated from the peak, but the deteriorating growth outlook will limit any follow-through. The IMF’s base case for 2009 is for the global economy, at best, to just skirt a recession. Industrialized economies from the US to the UK, Germany, France, Japan, Switzerland, Sweden, New Zealand, and Australia are either in or teetering on the edge of recession, by the yardstick of two quarters of negative growth. Canada is expected to avoid a recession, but only by the skin of its teeth. The BoC has slashed its outlook for Canadian GDP growth from 1.0% in 2008 and 2.3% in 2009 to a mediocre pace of 0.6% in each year, including a contraction in 2008 Q4.

As discussed recently, the global business cycle and its impact on commodity prices dominate USD/CAD. At present, and for some time, the global economy will be USD/CAD supportive. Certainly, the recent rally in USD/CAD was historically extreme, but so was the carnage in commodities. The CRB index fell 23.6% in October — the largest one-month decline on record to 1957. As well, the Baltic dry index has collapsed alongside emerging market equities indicative of slowing global demand and trade. Not a surprisingly, a commodity and cyclically-sensitive currency such as CAD has experienced some unprecedented moves.

The easing of USD funding stress has provided some welcome relief to the intense USD buying. However, global economic headwinds remain strong and will limit sustained commodity price rallies and USD/CAD selloffs until the severity of the cyclical slowdown becomes clear and the focus rotates to the timing and strength of the eventual rebound. This won’t likely occur until well into 2009.

With expectations that the global economic system won’t be impaired by the financial crisis, it is appropriate to focus on longer term oil prices and the implications for USD/CAD in late 2009 and 2010. What matters for the future performance of USD/CAD is whether financial market turmoil causes a sharp decline in long-term oil price expectations. That has not yet happened. For example, the December 2009 WTI oil future is currently at US$72.4/b. Clearly, short-term oil demand is retreating. The IEA has forecast that demand for oil in developed countries will decline by 2.2%y/y in 2008, with little offset from China or India. However, in the next few years, as the global economy passes the trough of the current downturn, the IEA expects oil demand in the emerging world, most notably China, to be quite strong, accounting for most if not all of increased oil demand in coming years. As well, the risk of sharp declines in production in
several key non-OPEC producers, including the North Sea, Russia and Alaska is significant. Thus, despite intense short-term downside risks to oil demand, longer-term demand/supply fundamentals remain solid. Thus, estimates of longer-term oil prices above US$70/b seem very reasonable. In fact, a sharp tightening of the oil supply/demand balance cannot be ruled out in 2010 or beyond, suggesting that oil could trade closer to $100/b long-term. As oil market conditions improve in coming years Canadian oil sands production will expand sharply. That will be when CAD truly blossoms as a petro-currency, with China the key, particularly if Canada makes the requisite infrastructure investments to more regularly tap Chinese demand for oil.