Welcome to currency roulette, the investing game that all Canadians have to play, whether they want to or not.
The game consists of choosing the currency that will best harbour your wealth. Over the past decade the winners in Canada were the stay-at-homes – the folks who ignored the lure of the United States in favour of keeping their money in Canadian stocks and bonds and GICs. During that time the Canadian dollar shot from 65 cents (U.S.) to near parity with the greenback. That high-pitched whine you kept hearing in the background? Cries of pain from Canadians caught holding U.S. stocks and bonds that were worth less and less in loonie terms with each passing year.
But the next decade is going to be different. By several yardsticks, our currency is overvalued. And that suggests that those who want superior results should look at the case for moving more of their money across the border.
The most mouth-watering measure of the loonie’s value is hamburger prices. The Big Mac index, compiled by the Economist magazine, compares the purchasing power of various currencies by looking at the price of the Golden Arches’ trademark sandwich around the world. In recent months, the index has consistently shown the loonie to be overvalued by 10 per cent or so versus its U.S. counterpart.
A less tasty but more scientific approach is provided by the purchasing power parity (PPP) indices calculated by the Organization for Economic Co-operation and Development. The PPP figures, which compare the buying power of numerous currencies, suggest the loonie is overvalued by around 16 per cent against the greenback.
The muscular loonie is reflected in Canada’s surging current-account deficit. Our national trade gap has swelled to record levels in part because it’s cheaper for Canadians to buy goods outside the country than within. And the most likely way that gap will be reversed will be for the loonie to fall.
Granted, the fall may take a while. While currencies often follow the path indicated by PPP numbers and current account deficits, the snapback usually takes a while.
Still, counting on a gradual decline of the loonie versus its U.S. counterpart is an excellent long-term bet. Despite all the worries that quantitative easing will “debase” the greenback, it’s still the currency of choice when risk appears. For now, the loonie is being supported by surging commodity prices, but some of the world’s smartest investors, including Prem Watsa, chairman of Fairfax Financial Holdings Ltd., believe that commodity markets are ripe for a fall.
Investors who can afford to be patient should think about using the mighty loonie to snap up some bargains denominated in U.S. dollars.
One strategy is to buy U.S. bonds. While yields aren’t attractive on the surface, they look much better if you assume that you’ll get paid back in U.S. dollars that will be worth more in the future than they are now in loonie terms.
You can buy U.S. Treasuries through several exchange-traded funds offered by iShares. For instance, the Barclays 20-plus Year Treasury Bond Fund – which I own – holds a range of long-term U.S. Treasuries with an average maturity of nearly 28 years. You can also choose ETFs that focus on Treasury bonds of shorter maturities, as well as funds that specialize in various flavours of U.S. corporate bonds.
If bonds aren’t your thing, take a peek at U.S. stocks with attractive valuations, reasonable debt levels and records of dividend increases. Safety-conscious investors should look first at firms making essential products. These companies aren’t likely to suffer a major hit no matter what lies ahead for the North American economy.
Consider J.M. Smucker Co. , maker of kitchen staples such as coffee, peanut butter, jam, jellies and preserves. It trades for 15 times earnings, has doubled its revenue and earnings over the past four years, and offers a 2.5-per-cent dividend yield to boot. Smucker isn’t flashy, but it offers potential to benefit from a more exuberant economy as well as protection against a harsher outlook (even in a recession, people drink coffee and eat peanut butter).
Another choice for those who like their stocks to be safe and sensible is Archer Daniels Midland Co. , the agribusiness giant. Its business of processing agricultural commodities is boring in the extreme, but the company is huge, has significant exposure to fast-growing emerging markets, and – best of all – is cheap. It trades for only 11 times earnings and pays a 2 per cent dividend yield.
After a decade of watching their U.S. investments go nowhere, most Canadians aren’t eager to venture across the border. Which, of course, suggests that now is the time to do just that.