Falling loonie could have investors flying high

By Dale Jackson
Globe Investor Magazine Online, Aug. 15, 2008

Dale Jackson is a producer at Business News Network.

It could be pay-back time for investors who have been sinking their money into U.S. equities and getting stung by the strong Canadian dollar. The loonie is losing altitude and for anyone with a big stake in foreign securities that’s good news.

If you had put your savings into beaten-down U.S. equities in the early part of the decade you likely got sideswiped when the investment was converted to Canadian dollars. From the start of 2002 the loonie skyrocketed from 61.75 cents against the U.S. dollar to last October’s high of $1.06. Over that same period U.S. equities gained 12.5 per cent but the average Canadian-dollar-denominated U.S. equity fund flat-lined.

High commodity prices and a weak U.S. dollar fuelled the loonie’s rise. Now, weakening commodity prices and a strengthening U.S. dollar have yanked the Canadian dollar from its October 2007 high of $1.06 to below 94 cents this week.

Meg Browne, senior currency strategist with Browne Brothers Harriman says the effects of the slumping U.S. economy are trickling into Canada in the form of weak employment and housing. “The Canadian dollar has already topped against the U.S. dollar and we think it will also be trending lower,” she says.

Browne Brothers Harriman is not alone in its bearish outlook for the Canadian dollar, which has depreciated 5.5 per cent against the U.S. dollar since July 11 when crude oil hit a record $147 a barrel. A median estimate of 31 economists is calling for the loonie to weaken to 92 cents by the end of 2009. Goldman Sachs has targeted the loonie to drop to 88 cents within one year.

Ms. Browne points out the downward trend for the loonie is long term but suggests Canadian investors will still have opportunities to buy their favourite U.S. equities when the Canadian dollar rallies on spikes. “That doesn’t mean we won’t have a little correction and that will provide longer-term investors with an opportunity to buy into the U.S. dollar.”

Warning lights are flashing for Bob Tebbutt at Peregrine Financial Group Canada. He uses currencies and commodities to manage risk for big institutional investors. “I’m directing my sales effort to people that need protection against the Canadian dollar falling,” he says.

He says the Canadian dollar is showing signs of weakness but isn’t so sure the U.S. dollar is up for the challenge on a global level against currencies like the euro and yen. “I’m of the opinion that the U.S. dollar is still in a major downtrend that started eight years ago” says Mr. Tebbutt.

The greenback has rallied this month against the euro as currency traders bet the U.S. economic slowdown is spreading to Europe. Wells Fargo & Co. says there are signs the U.S. economy is much closer to a bottom than Europe and expects the U.S. dollar to continue strengthening.

However, Bank of America Corp. is telling its clients to expect the U.S. dollar to resume weakening against major global currencies until the second half of next year. Morgan Stanley is calling for the greenback to near a record low against other major currencies by October.

Institutional investors with deep pockets have a wide variety of hedge strategies to choose from but for the retail investor options are limited. U.S. dollar accounts are not permitted in registered retirement savings plans but many mutual fund companies offer U.S. denominated versions of their funds – the holdings and weightings are basically the same but one holds assets in Canadian dollars and the other holds assets in U.S. dollars. In most cases the funds have the same name but the U.S. denominated fund will include “currency”, “neutral” or “(U.S.)” in the name.

Retail investors can get indirect exposure to the currency trade through global bond funds since bond yields are linked to interest rates and currencies.

Funds are also available to high net worth investors looking for exclusive currency plays or hedge funds that may incorporate currency trades in their strategy.

One pure play currency fund is Friedberg Currency, managed by Friedberg Mercantile Group Ltd. The fund makes speculative trades in currency futures and has managed to post a return of 12 per cent so far this year. Trading in currency futures can be extremely volatile as seen in a three-year chart of the fund’s performance. RBC Dominion Securities investment adviser Marilyn Trentos says currency trading is always a risky business and cautions retail investors not to go it alone. “You can’t just be flipping back and forth as a retail investor. You leave that for the big boys.”

Ms. Trentos is advising her clients to do nothing – regardless of the outlook for the Canadian dollar. She says investors should never let currency concerns over-ride basic investment fundamentals and advises anyone who plans to travel or live within the United States to always hold separate U.S. and Canadian accounts outside of an RRSP as a permanent hedge. “If you have reasons to have U.S. dollars and U.S. income, then stick with it,” she says.

Special to The Globe and Mail