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(Ryan Remiorz/Ryan Remiorz/The Canadian Press)
(Ryan Remiorz/Ryan Remiorz/The Canadian Press)

ROB Magazine

Is a high loonie the new normal? Add to ...

A loonie worth well over $1 (U.S.) is bad news for Canadian exporters, but welcome news for investors. U.S. stocks have rarely been available at such deep discounts. Sure, the U.S. economy is struggling, but the country is still home to the vast majority of the world's dominant businesses.

Take General Electric. Its shares have traded at about $20 (U.S.) lately. With the loonie worth $1.05 (U.S.), that translates into a Canadian-dollar price of roughly $19. If our dollar was worth 65 cents (U.S.), as it was a decade ago, the price would be more than $30. So Canadians are getting quite a deal, right?

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Maybe. A sound thesis must be able to run a gauntlet of risks and emerge intact. This one faces some obvious hurdles. For example: Dividends will be paid in U.S. dollars, and you'll lose on the exchange if you convert them back to loonies.

But that's a minor flaw compared with some very questionable long-term assumptions that buy-American investors are making. A lot of them figure that the Canadian dollar will eventually drift back to about 80 cents (U.S.). Economists who use tools such as the purchasing power parity theorem-which says that, in the long run, exchange rates adjust so that the real prices of the same goods in different countries are equal-say that's about the right value.

Suppose you buy GE today for $20 (U.S.) a share and that price climbs by 10% over the next year. Also assume that the U.S. dollar gains strength and the loonie declines to 80 cents (U.S.). Your Canadian-dollar return will be 45%. Pop the champagne cork.

But just because the loonie is high now doesn't mean it will come down. OECD economists say the dollar should be worth about 82 cents (U.S.) based on purchasing power parity. But the OECD said the same thing when it was trading at 65 cents (U.S.). Currency markets have a mind of their own.

Why has the loonie been so strong in recent years? Partly because of the high prices of commodities such as oil, gold, copper and zinc, which Canadian companies produce in abundance. Demand for those commodities probably won't plunge soon.

But there's another reason our dollar is rising against the greenback: The United States is in big financial trouble. According to Washington's own projections, total U.S. public debt will soar to 350% of the value of annual GDP by 2085. That ratio is "only" 62% today.

It's difficult for a country to go broke if it controls its own currency. Washington has essentially been printing money to pay its bills lately. Some U.S. politicians warn of financial Armageddon, but few of them really mind a falling greenback-it boosts exports and it creates jobs. By contrast, our government and the Bank of Canada don't seem too fussed about a surging loonie, which puts downward pressure on import prices, thereby helping to keep inflation low.

It's probably safe to say that the Canadian dollar will fall relative to the greenback some day, but that could take a long time. In the interim, the loonie could climb even higher, and eat into investors' returns on U.S. stocks. Going back to the GE example: If the company's share price climbs by 10% over the next year, but the loonie climbs to $1.15 (U.S.), you won't make much of anything at all. Currencies can often fool you twice.



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TIP SHEET

VALUE:

Intertape Polymer Group $27.9 million 2010 EBITDA (U.S. dollars)

The company has a funny name, but there's nothing funny about the company. The share price peaked near $45 in the late 1990s. It's now about $1.30. Here's the opportunity: The Montreal-based manufacturer of tape and other packaging material has annual revenues of about $750 million (U.S.), but its stock market capitalization is only about $80 million. Yes, it's lost money in recent years, but it doesn't take much of a profit to move the needle, and it looks like better times are nigh. Now investors are laughing.

GROWTH:

Alaris Royalty Corp. 12.2 Forward P/E ratio

Alaris provides financing for private companies that can't get it elsewhere, or don't want to. That sounds like a risky business, which is true. But where there's risk, there's reward, and the returns the company earns on its investments are reflected in its 7% dividend yield and its surging share price. As the economy improves, so should both of these yardsticks, giving investors "alternative" (read "superlative") returns.

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