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trend spotters

A 1 euro coin sits atop a $1 (U.S.) note.Martin Meissner/The Associated Press

Another seismic shift in the Canadian dollar may already be under way and unsuspecting investors could pay dearly.

The value of the loonie has been drifting lower against other major currencies as global growth slows, and demand for the resources we export falls.

At 95 cents to the U.S. dollar, our dollar is well below its late 2007 high of $1.10. Trying to predict the direction of any currency is always a bit of a crapshoot but any major shift in the Canada-U.S. dollar relationship could have a profound impact on Canadians with property or investments outside the country.

First, a little history: The Canadian dollar experienced its biggest shift in relation to the U.S. dollar between 2002 and 2007 when it climbed 80 per cent from its 62-cent low to $1.10. In that five years, Canadians with U.S. denominated holdings saw their investments plunge in value when they were converted to Canadian dollars.

The opposite threat could be present today. A quick plunge in the Canadian dollar would seriously diminish the buying power of Canadians who want to invest or spend their retirement in the U.S. or overseas.

Some investors have taken advantage of the high loonie to stock up on U.S. denominated investments but Richardson GMP portfolio manager Craig Machel says speculating on currency rates can be a dangerous game. He manages money for high net-worth clients with homes and financial interests around the world and specializes in devising hedge strategies to smooth out currency moves.

"Our portfolios are structured so we're not making bets on things like currencies. We just don't make macro calls or macro bets," he says.

Currency hedges are set up according to a client's individual circumstances and goals – whether it's vacationing in Florida or owning a villa in Tuscany. "It comes down to owning the currency you are going to use in the future," he says. "You want to have that purchasing power that isn't subject to foreign exchange rates."

He says flexibility is the key, so investors aren't forced to sell assets in one denomination to pay for things in another denomination.

Hedge strategies can apply to any currency but for most Canadians the U.S. dollar relationship is the most important for two reasons: it's where we spend most of our money outside Canada, and the greenback is the global standard accepted just about anywhere.

A good currency hedge, Mr. Machel says, involves investing a tailored portion of a client's overall portfolio in strategies that are not only in U.S. dollars, but regularly pay out U.S. dollars. "They're not only able to set themselves up to create an income, but they also have a U.S. dollar allocation which is paid for."

His U.S. currency hedges of choice are U.S. equity mutual funds domiciled in Canada from specialty companies. One example is a U.S. mortgage fund offered by Trez Capital. He likes it because it pays out a steady stream of U.S. dollar mortgage income and there's little risk of the initial investment losing money. "We simply reinvest that in a U.S. dollar denominated fund or we'll spin it out in income to clients that need the U.S. dollar income," he says.

However, currency hedging has its risks. The best hedges prohibit investors from gaining from currency fluctuations. Investors who have been loading up on U.S. dollar investments will be rewarded handsomely when they are converted back to Canadian dollars if the Canadian dollar falls. "It's a trait we've seen emerge in terms of retail investor behaviour and how they approach the U.S. dollar," says TD Securities chief currency strategist Shaun Osborne.

TD's short-term projections look promising for those investors. Mr. Osborne expects the Canadian dollar to drop to 90 cents to one U.S. dollar by the end of 2014. "It's not a significant move but quite a decent move. If there are any risks to that view it's probably to the downside for the Canadian dollar," he says.

However, for investors looking for a longer-term trend, he cautions the currency waters are murky. Many would use an averaging calculation called mean reversion trade that indicates a lower loonie, long-term. "That would point to perhaps a bit more Canadian dollar softness getting us back to somewhere closer to 80 or 85 cents."

He says forecasting the Canadian dollar is essentially forecasting the price of commodities because natural resources such as oil are our biggest exports. "The most recent swing up in the Canadian dollar has really been driven by the commodity super-cycle," he says. "The Canadian economy is still heavily commodity reliant."

That commodity super-cycle has been fuelled by low borrowing rates set by the world's central banks in the wake of the 2007-2008 financial meltdown. When central banks pull back on stimulus in the new year, rates are expected to rise, limiting access to cheap money. "It's arguable, given moderating growth in emerging markets – particularly China – and the fact that we're seeing central banks slowly start to edge away from non conventional monetary policy, that a lot of the impetus behind the commodity super-cycle is starting to weaken."

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