The Canadian dollar has dropped 4.5 per cent year to date, but a combination of weak domestic energy prices and uncertain outlook in the mining sector means that further declines may be in store.
The U.S. dollar value of the loonie has historically tracked the performance of domestic materials stocks (usually with a bit of a lag). This reflects the global investor perception that the Canadian dollar is a hard asset currency.
The huge divergence between the loonie and S&P/TSX Materials Index that I noted in July has largely, but not completely, closed.
S&P/TSX Materials index vs CAD/USD
SOURCE: Scott Barlow/Bloomberg
The energy stocks in the materials index are now faced with a massive drop in domestic oil prices. Pipeline capacity issues have caused a 26 per cent bloodbath in West Canada Select crude prices since mid-October, and it doesn’t appear that this is reflected in oil stock prices yet.
Credit Suisse strategist Andrew Garthwaite (formerly ranked #1 strategist in the world by Institutional Investor) recently presented a bearish view on the mining sector that, if accurate, will also weigh on Canadian materials stocks.
Mr. Garthwaite writes, “we stay underweight mining… . Iron ore and copper have excess supply which often requires a third of production to fall below cash costs; relative P/Es are high.” He believes that the global copper and iron ore miners are entering a period where they will lose money on a third of their production, a trend that will not help profitability levels.
Market history indicates that the loonie will decline along with materials stocks. For Canadian investors, this means cutting exposure to materials and adding to foreign asset exposure.
Scott Barlow