Daily Gains Letter

How to Profit from the Canadian Dollar’s Short-Term Future

By for Daily Gains Letter |

Investors Find Short-Term Gains North of the BorderWhen the financial crisis struck the U.S. economy, banks struggled. Giants like Lehman Brothers went into bankruptcy, while others were forced to merge. No matter where you looked, the financial system appeared to be in very poor shape. This phenomenon not only created havoc in the U.S. economy, but sent ripple effects into the global economy, as well.

In the midst of all this, when the financial systems in the U.S. economy were on the verge of collapse, our neighbor to the north, Canada, didn’t really experience anywhere near as much of a financial crisis.

The banking system in the country remained strong because the Canadian banks were not as exposed to the “bad assets” that were at the root of the U.S. banks’ problems.

During the financial crisis in the U.S. economy, Canada was one of the few G7 countries that were actually able to prosper. The Canadian dollar, compared to other major currencies in the world, increased in value. Take a look at the chart below:

Canadian Dollar Chart

Chart courtesy of www.StockCharts.com

In early 2009, the Canadian dollar was hovering around US$0.77; now, it trades at US$0.95—23.3% higher. In early 2011, and again later in the year, the Canadian dollar actually surpassed US$1.05.

But it appears that the Canadian dollar now faces some headwinds, which could drive it lower and hurt the trend it has been following since the financial crisis.

To begin with, the Canadian economy is slowing. This year, the Bank of Canada expects the country’s economy to grow at a slower pace than the previous year, expecting growth of 1.5%, compared to 1.8% in 2012. (Source: “Clouds Over Canada Damp Loonie,” Wall Street Journal, July 1, 2013.)

Unfortunately, this isn’t the only problem facing the Canadian dollar. Personal debt in Canada has reached dangerous levels. In the first quarter of 2013, the ratio of household debt to income stood at 161.8%; that’s only slightly down from the third quarter of 2012, when it reached its high at 162.8%, but still beyond manageable levels.

To put that into perspective, at the end of 2012, the household debt compared to the gross domestic product (GDP) of Canada stood at almost 94.5%—and has been trending higher. (Source: “Household Debt to GDP for Canada,” Federal Reserve Bank of St. Louis web site, last accessed July 4, 2013.)

That’s a poor showing when compared to the U.S. economy, in which the ratio of household debt to GDP was almost 85% in the fourth quarter of 2012, and is in decline. (Source: “Household Debt to GDP for United States,” Federal Reserve Bank of St. Louis web site, last accessed July 4, 2013.)

Other troubles continue to brew in the Canadian economy, as well. For example, the housing market continues to soar in the country, while commodities prices and demand continue to slump.

If these factors continue to take a toll on the Canadian economy, the Canadian dollar will likely take a major tumble. It has been continuously declining since late 2012 and may fall further still.

To profit from this situation, investors may look to short exchange-traded funds (ETFs) like the CurrencyShares Canadian Dollar Trust (NYSEArca/FXC). This ETF tracks the performance of the Canadian dollar and may just be an easier route for investors to profit from than going to the foreign exchange market.

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