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Hedge fund's bet against Canada may be right, but timing is key

A Canadian flag flies over downtown Ottawa on June 30, 2011.

BLAIR GABLE/REUTERS

Kudos to the contrarians. But they better hope they've got their timing down pat.

This weekend, Vijai Mohan, a San Francisco-based hedge fund manager, made a splash when the Globe reported that he's short the Canadian economy, meaning he expects the values of our banks and the loonie to tumble. Mr. Mohan's so sure of it, he's bet 95 per cent of his investors' assets on these positions.

You know what? He's got a point. For the past few years the Canadian dollar remained strong relative to the greenback because our economy was growing at a faster clip and investors expected Mark Carney to raise interest rates before Ben Bernanke. Now that's not looking as likely.

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As for our beloved Big Six banks, Canadian consumers have already reached record household debt levels and Mr. Mohan believes that the amount of capital the banks must hold against mortgages they underwrite is much too low.

Call him a hater, but I think Mr. Mohan's got a lot of brass. The federal government keeps touting our economic strength, yet the numbers show we're slipping behind some key peers – chiefly the United States. Their unemployment situation is much more dire, but the U.S. economy is now growing at a faster pace than Canada's, and the recovering housing market is giving consumers confidence to spend a bit more freely.

So good on Mr. Mohan. At the very least he's stripped some of the silly veneer off our shaky economy.

But here's the problem: even if he's right, he may only win half the battle. Timing is everything when it comes to trading.

Just look at the experiences of those who believed the U.S. sub-prime crisis would unfold the way it did. We often hear about the likes of John Paulson, who made billions, but the truth is there were countless others who made the same trade. The only problem is that they executed it too early.

To bet against sub-prime securities, the bears typically bought credit default swaps, which served as a sort of insurance on mortgage-backed securities. While they waited, they had to pay insurance premiums, and after a while these premiums simply got too expensive for those who were early to spot the problems.

Similarly, when you short Canadian banks, you must pay their quarterly dividends until you cover your position.

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Let's hope Mr. Mohan's aware that for over a year now countless people have expected the banks to start showing signs of slowing growth. Even their chief executive officers have made comments about how hard it is to grow when so many Canadians are over-indebted.

And then every quarter they've put out another set stellar numbers. In February, Royal Bank of Canada's profit even hit a stunning $2.1-billion.

Should our demise ultimately unfold, Mr. Mohan will look smart. But it may not mean much to his investors.

As the Globe's David Parkinson told me this weekend, a prominent economist once said to him: "I was right, but I was a year early. That's the same as being wrong."

(Tim Kiladze is a Globe and Mail Reporter.)

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