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October 2007
The Loonie; no longer the Dodo (at least for a while…)
During the sixteenth century, European colonialists arrived in a strange new land known as
“Kanata”, an Iroquois-Huron word meaning “village”. During their first winter, the settlers realized
they were in desperate need of additional warm clothing. They noticed the locals wore animal furs
which shielded them from the extreme climate. The colonialists wanted to acquire some of these
pelts but faced a major dilemma; there were no bank machines in the area, and thus had nothing
to give the locals in exchange for their goods. So the settlers approached the local leaders and
asked how they could obtain some winter clothing. Because the locals were impressed with the
tools they had seen the Europeans using, they struck a deal; the colonialists could have some of
the furs, if they used their tools to make jewelry for the locals out of indigenous shells and stone.
This jewelry became known as “wampum”, and was the first Canadian currency. It was widely
used throughout early Canada and even into Northern USA, where the value was pegged to the
American penny: eight white beads or four purple beads.
Since the wampum, Canadians have used many objects as currency; beaver pelts, coins from
France, Spanish piastres (dollars), British gold and even playing cards for a time. It wasn’t until
1851 that Canada adopted “dollars and cents”. At that time, Canadian and US dollars traded at
par (meaning they were of equal value) and were redeemable from the government for exactly
23.22 grains of gold.
In Canada, for most of the late 1800’s Canadian and US dollars were used interchangeably, at
least among individuals and merchants. The form of legal tender at that time was primarily coins,
whose value was linked to the metal they were crafted from. In 1870 however, Canadian banks
became aware that US silver coins contained less bullion than their face value suggested.
Therefore, Canada passed a law which pegged the US dollar at 80 cents Canadian.
Until the outbreak of the First World War, the values of most major currencies (Canadian, US and
Britain for example) were fixed to the price of gold; at any time, paper money could be exchanged
for bullion. The exchange rate between currencies under this system was limited to how profitably
someone could physically export or import gold from one country to another. For example, the
cost of insuring and shipping gold to and from New York and Montreal (Canada’s financial centre
at the time) was fairly low due to their proximity. This meant the currency exchange rate between
the two countries was generally fixed at $1 USD for $1 Canadian as long as the cost of
transporting gold did not materially change. The one exception to this guideline was during the
American Civil War where in July 1864, the US Greenback (yes, called so because of its colour)
was worth only 36 cents to one Canadian dollar.
In 1970, due to inflation concerns, Canada decided to allow the dollar to “float”. This was a major
change as it meant the government had far less control over the value of its own money. From
now on, supply and demand for Canadian dollars would dictate exchange rates. Here’s how this
works: There are two (in a simplified model) influences on currency exchange rates:
economic/political stability and foreign investment interest. Simply put, a country with a
stable government, a growing and healthy economy and relatively high investment rates
will have a better (higher) exchange rate than a country with a volatile government, declining
economic growth and poor investment opportunities. Currently, Canada fits the former description
and the US fits the latter. Canada has a fairly stable government (much to Stephane Dion’s
chagrin), a very healthy economy (two of our largest sectors, energy and materials like gold, are
setting new highs almost daily), and our interest rates are steady. While the US government is in
disarray, its economy is under stress and it continues to lower interest rates. This is why the
Canadian dollar has skyrocketed against the US dollar over the past months. In 2002, the
Canadian dollar traded at 62 cents US, while today the Canadian dollar is trading almost 70%
higher at $1.05.
What this means to you the investor is that any investment in assets (stocks, bonds, cash, real
estate, etc) made in a currency other than Canadian dollars, is not having a good year in 2007. To
the end of October, the Canadian dollar has appreciated over 20% against the US dollar, 19%
against the Japanese Yen, 18% against the British Pound and 13% against the Euro. This means
that if you invested in a US stock on January 1, 2007, and that stock rose 20% in value, when you
looked at your statement in October 2007 in Canadian dollars, you would see a rate of return of
zero. Put another way, any one percent increase in the Canadian dollar against currency X,
counts as a one percent decrease in the return on any asset denominated in currency X.
While your investment portfolio with Stewart Financial is performing well, the most recent
statement you received appears to show otherwise. I’m sure you opened your quarterly statement
and were disappointed to see you had lost a little ground. I believe this is a temporary situation; in
fact it is a buying opportunity. The US still has the largest economy in the world by far, and
Canada only ranks 14th. The valuation of the Canadian dollar surely will not stay at its current level
forever. The average valuation of the loonie against the US dollar over the past 35 years has been
80 cents. As soon as oil and commodity prices retreat and the US straightens their ship, the dollar
will correct itself. While this may not happen next week or next month, in time things will rebalance.
They always do.
Our “Balanced Portfolio” performance year to date (to the end of September) in local currency (that
is, valued in the currency where the stocks are located) has increased 6.7%. However, when
converted to Canadian dollars has increased only 1.9% in the first nine months of 2007.
During the most recent quarter the Balanced Portfolio
decreased 1.1% in Canadian dollars and increased 1.8%
in local currency. Because the global economy is in
fact in good shape, my expectation is that markets will
continue to perform well for the balance of the year.
However, returns outside of Canada may be moderated
if the Canadian dollar continues its rise.
Your hoping Canadian book stores start charging
US dollar prices investment advisor,
Duncan Stewart, MBA, CIM, CIMA
[email protected]
“Rapidly recovering”
Montreal Star, 1932