Canadian Dollar Falls Prey to Funds as Oil Drops

Date: Monday, January 15, 2007
Author: Haris Anwar, Bloomberg.com

Jan. 15 (Bloomberg) -- Traders are making the biggest bets ever against the Canadian dollar.

Hedge funds and other large speculators started the year with a record C$8.5 billion ($7.2 billion) wagered that the currency will fall against the U.S. dollar. Canada's dollar tumbled to a 13-month low last week amid slower economic growth and a 33 percent slide in crude oil since July.

``There are all kinds of horrible things happening to the currency,'' said John Taylor, chairman of FX Concepts Inc., a New York firm that manages $12 billion in currencies. ``Crude oil, lumber, and copper markets look ugly at this time. Most of the hedge funds are out of the Canadian-dollar trade, and I don't see any sign that they'll come back soon.'' Taylor exited bets on the currency in the summer.

Investors held a net 84,906 contracts betting on a decline in the Canadian dollar as of Jan. 9 on the Chicago Mercantile Exchange, up from 74,268 on Jan. 2, according to the Washington- based Commodity Futures Trading Commission. The commission publishes data since 1986 on its Web site.

The Canadian dollar rose last week to 85.44 U.S. cents on Jan. 12, after six weeks of straight losses. It has shed more than 6 percent since May 31, when it reached a 28-year high of 91.44 cents. Canada's currency fell for the first time in five years during 2006. The dollar rose 0.3 percent to 85.66 U.S. cents at 8:12 a.m. in Toronto.

More Bearish

Foreign-exchange analysts grew more bearish on the currency as prices for commodities, which account for about 54 percent of Canada's exports, declined. Crude oil fell to the lowest price in 19 months last week. Copper has plunged 36 percent from its record high in May.

Canada's economy, the world's eighth largest, failed to grow in September and October and exports to the U.S. declined. Factory shipments fell for the third straight month in October to the lowest level in almost two years.

Lehman Brothers Holdings Inc. forecasts the currency will drop to C$1.20 by June and C$1.25 by December. Merrill Lynch & Co. predicts it will hit C$1.20 by September. Morgan Stanley forecasts the currency will drop to C$1.17 by the end of the second quarter and C$1.20 in December. All the firms are based in New York.

``The business cycle in Canada isn't at the point where investors reward currencies,'' said Stephen Jen, head of global currency research at Morgan Stanley in London. ``The economy is slowing and the central bank is near cutting interest rates,'' said Jen, who correctly predicted in July a rally was ending. ``It's still sensible to sell the Canadian dollar.''

Technical Traders

Traders who use historical charts and price movements to predict trends said the Canadian dollar may rebound. The so- called relative strength index, a gauge measuring the momentum of gains in the U.S. dollar against the Canadian currency, rose above 70 last week, a level that traders say suggests the U.S. dollar will fall.

Analysts also said the record number of contracts looking for a decline may show most speculators have already placed their bets against the currency.

``The risk is growing that we'll not be able to sustain the break above C$1.1850, and more likely to see a price correction down to around C$1.150,'' said George Davis, the Toronto-based chief foreign exchange technical analyst at RBC Capital Markets, a unit of Royal Bank of Canada, the country's largest bank by assets.

Bank of Canada Governor David Dodge said on Jan.7 the decline in the Canadian dollar reflects ``fundamentals,'' and isn't ``surprising.'' Canada's benchmark lending rate of 4.25 percent is one percentage point lower than the Federal Reserve's 5.25 percent. The Bank of Canada's next interest-rate meeting is on Jan. 16.

Interest Rates

``With interest rates below those of the U.S. by a significant margin, industrial competitiveness waning and resource prices appearing to have peaked, the intermediate outlook for the currency is negative,'' said David Gerstenhaber, who oversees $400 million at New York-based Argonaut Capital Management.

Gerstenhaber, who worked at Tiger Management LLC and Soros Fund Management LLC, said he made money betting against the currency last year and anticipates making more this year.

``The Canadian dollar is overvalued,'' he said.

The number of economists who forecast the currency's decline has increased since Oct. 31, when the federal government said it plans to scrap the tax advantage for high-yielding income trusts, the favorite investment of foreign investors.

By organizing as a trust, companies avoid most corporate taxes because they pay the bulk of their cash flow to investors in monthly dividends. Investors pay taxes on the payouts at a rate of 46 percent. The standard corporate-tax rate is 21 percent.

Income Trusts

Income trusts accounted for a third of the country's record $28.1 billion of equity sales last year after mushrooming almost eightfold since 2001.

``I stopped being bullish on the Canadian dollar that day,'' said Dennis Gartman, an economist and the editor and publisher of the Suffolk, Virginia-based Gartman Letter. Gartman was predicting until last year that the currency will rise to 1 against the U.S. dollar.

``The currency will be weaker in a month from where it's now, and after six months from where it's now,'' said Gartman. ``The trend is for a weaker Canadian dollar.''

To contact the reporter on this story: Haris Anwar in Toronto at Hanwar2@bloomberg.net .