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scott barlow

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I'm going to keep coming back to this chart comparing the Canadian dollar and the S&P/TSX materials index. Not only do I think it's the most important chart to follow for Canadian investors, I think it's one of the most important charts in the world.

If you view the chart as a scorecard for the biggest, most important current market debate – is global growth leadership moving sustainably from emerging markets to the U.S. and Europe? – then you can see what I mean.

To recap: there is a divergence between materials stock values and the loonie exchange rate. The divergence implies that the domestic currency is either really overvalued or that materials stock are set to rally.

Thursday, the Canadian dollar made a big move lower (about half a cent) and materials stocks rallied 2.3 per cent. This partially resolved the divergence but offered little clarity on future market direction. Essentially, the emerging markets and developed markets fought to a tie. For a clear trend, we'd need one line make a bigger move towards the other.

Continued strength in the Canadian materials sector – which is highly sensitive to Chinese and broader emerging markets growth – would suggest that global economic leadership will remain centered in the emerging markets. It also suggests that domestic markets will once again outperform the S&P 500.

A further fall in the loonie would confirm the 2013 weakness in the commodities industries. This would make it more likely that U.S. dollar assets will outperform the TSX and the MSCI Emerging Markets index.

There are a huge number of globally-significant economic factors determining the levels on the chart. The U.S. dollar, and by extension the U.S. financial system, play a major role in deciding the Canadian dollar exchange rate. China's economic reports, and the market's perception of their reliability, help drive materials stocks.

The future make-up of Canadian economic growth will also be foreshadowed with this analysis. A significantly weaker loonie means that manufacturing-heavy Ontario has a better chance of exhuming itself from the current slow growth doldrums. Its exports will be more competitive.

For investors, this is the chart to watch until the divergence has fully corrected. A rising materials index means keep your investment assets at home – the decade-long resources gravy train is back in service. A falling loonie suggests higher weightings in U.S. dollar assets.

Scott Barlow is a contributor to ROB Insight, the business commentary service available to Globe Unlimited subscribers. Click here to read more of his Insights, and follow Scott on Twitter at @SBarlow_ROB.

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