CAD to USD: This Number Can Start a Death Spiral for the Canadian Dollar

CAD to USDDownside for the Canadian Dollar?

Forex traders need to start thinking of the Canadian dollar as a trade on the Canadian economy. It’s not just an abstract number floating across a screen or the sum of technical movements. The CAD to USD reflects the underlying strength of the Canadian economy.

At the moment, there are high-frequency traders (HFTs) using algorithms and supercomputers to exploit every arbitrage opportunity on the market. There is simply no chance for us, the individual investors, to gain an edge.

You might as well walk into a casino and bet it all on red. Those are the odds you’re playing if you insist on day trading currencies, especially when leverage is involved.

At this point, I’m more interested in stretching the timeline to weeks and months. That way we’re all trading on a level playing field. Stretching the time horizon on your forex portfolio is a way of removing the advantage HFTs have built up.

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So let’s take a look at where the Canadian dollar is headed over the next few months.

Canadian Dollar Recap

Unless you spent the last two years wandering Siberia, you’ve probably heard of the oil price slump. Late in the summer of 2014, an oversupply of crude oil sent prices tumbling from $100.00 a barrel to $35.00 a barrel. The slump devastated oil-exporting nations like Canada.

During 2015, the Canadian dollar fell roughly 20% against the U.S. dollar. The drop was precipitous and calamitous in equal measure. But more to the point, it was directly the result of weakness in the energy sector.

Natural resources make up more than 50% of all Canadian exports, meaning the economy is vulnerable to a commodity slump. Economists have been warning of this exposure for a long time, but no one really cares during the boom times. (Source: “Key Facts and Figures on the Natural Resources Sector,” Natural Resources Canada web site, last accessed April 20, 2016.)

In any case, what’s done is done. Oil prices are unlikely to recover to previous levels, meaning that Canada’s next chapter of growth has to come from elsewhere in the economy. Unfortunately, the Canadian economy isn’t all that diversified.

Here’s a great chart of some data I borrowed from Garth Turner’s blog, The Greater Fool. It shows which industries have grown the most over the last nine years.
Canadian 2015 By Industry

Judging by this data, real estate seems the most likely prospect for continued growth.

Canada’s housing sector is world-famous for its impressive growth streak, particularly in the Toronto and Vancouver markets. But is it really strong enough to support the entire weight of the economy?

I certainly don’t think so. Low interest rates are propping up the struggling housing market for now, but the Bank of Canada can’t keep this up forever. Cracks are starting to show in the regional differences of home prices. Those who look close enough can see it.

For instance, the 2015 nationwide growth in house prices was negative if you remove Toronto and Vancouver. Canada has a housing bubble. International organizations like the Orangisation for Economic Co-Operation and Development (OECD) have been ringing alarms bells about it for some time now, but they seem to be falling on deaf ears. (Source: “Canadian Home Prices Soar 17% In A Year, But There Are ‘Radical Regional Differences’,” The Huffington Post, February 16, 2016.)

Fairly soon we’re going to see a collapse of the Canadian housing market. What do you suppose happens to the CAD to USD at that point? My guess is we’re going to see the Canadian dollar plummet like we never imagined possible.

Think about that when you open your trading window tomorrow. Think about making a trade based on solid fundamentals. I guarantee it’s a smarter idea than competing with HFT guys who vastly outgun you.