It's simple, right? The loonie's flight above par with the U.S. dollar is explained by the soaring price of oil. Canada's dollar, like Australia's, is a "commodity currency." Canada is a net exporter of oil, so the loonie's flight path is about the same as the cost of crude. It's always been thus - or at least it's been thus for as long as anyone in financial markets cares to remember.
But that relationship appears to be breaking down. "We have found that the correlation between oil and the Canadian dollar has collapsed," Marc Chandler, global head of currency strategy at New York-based Brown Brothers Harriman, wrote in a client note on Monday.
The Canadian dollar is at its highest level against its U.S. counterpart since 2007, yet is actually among the weakest performers among the Group of 10 major currencies since Feb. 15. (Only the New Zealand dollar, which has declined 1.8 per cent, and the British pound have performed worse.) While oil prices have surged 25 per cent in the period, the loonie has gained just less than 2 per cent.
Brown Brothers conducts a correlation analysis on a 60-day rolling basis, using percent change. The correlation peaked at the end of last year, at about 0.76. The correlation is now -0.1. This is the first time the correlation has been inverse since the July-October period of 2007, according to Brown Brothers. (Between 1992 and 2002, the correlation was often inverse, but in recent years this rarely has been the case, according to Mr. Chandler.
Mr. Chandler offers some explanations.
One, Canada's energy exports are in fact dominated by natural gas, the price of which has collapsed.
Something else to consider, advised Mr. Chandler: while the western provinces export heavy crude to the United States, the Eastern provinces import light sweet crude. In 2009, for example, Canada exported 658 million barrels of oil to the U.S., and imported 313 million barrels from places such as Britain, Norway and Algeria.
Mr. Chandler's third explanation is the most compelling. The Bank of Internationals Settlements calculates that the Canadian dollar's share of daily currency market is 5.3 per cent, which works out to daily volume of about $100-billion. By comparison, Canada exports about $6-billion of oil to the U.S. each month.
"The dollar value of oil exports is a miniscule fraction of the overall turnover of the Canadian dollar in the foreign exchange market," Mr. Chandler wrote. "Capital flows are more important than trade flows."
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