A View from the Trenches, March 4th, 2010: "The stars favor Canada"
Please, click here to read this article in pdf format: march-4-2010
(A brief announcement before we start with our comments today: Going
forward, “A View from Trenches” will not be published on a daily basis.
Over the past year, we enjoyed writing every day. However, we are very
busy of late, undertaking another project that hopefully will end by
next Fall. We will write as often as possible, but not on a daily basis.
Thank you so much for your support and understanding)
Since our last comments on Tuesday, we have had a few updates on
policy. The most important indeed is Greece’s announcement of
revenue-raising and budget-cutting measures . Since last week, the 5-yr
unsecured sovereign credit default swap spread has dropped dramatically,
from 400bps to 294bps (at close). If this issue was, as Mr. Jeffrey
Rosenberg sustains, a short liquidity problem, things should be left
there, with us waiting for the results yielded by the budget plan. But
as we clearly made the case before, this problem goes beyond the sphere
of liquidity. It is an institutional problem, and as such, we will have
to follow Germany’s reaction vis a vis Greece’s initiatives. So far,
Prime Minister Merkel made it clear yesterday that the next meeting this
Friday will not be about aid commitments.
In our view, these budget announcements have no purpose but to set
the necessary conditions towards a more sustainable institutional
framework, where either or both Germany and France guarantee Greek
issuances. However, an impressive opposition is growing in Germany
against this move. On this issue, Mr. Otmar Issing (Economist, former
member of the board of the Deutsche Bundesbank (1990–1998) and of the
Executive Board of the European Central Bank (1998–2006) couldn’t have
been more explicit: “Garantien für die Käufer griechischer Anleihen
durch die bundeseigene Förderbankgruppe KfW kommen überhaupt nicht in
Frage”, reported the online edition of Frankfurter Allgemeine (Our
translation: Guarantees for the buyers of Greek liabilities through a
KfW Bank Group are out of the question).
On a separate but related note, we have not been bullish of gold
lately. In our opinion, gold in terms of Canadian dollars was a poor
investment decision. In hindsight, we believe this was a correct view.
And looking forward, we maintain such view. In Chart 1 below (source:
Bloomberg), we show the ETF “XIU.TO”, that tracks the S&P TSX 60
composite (white) vs. the ETF “IGT.TO”, which tracks the price of gold,
in Canadian dollars. As can be seen, since Feb. 8th, when sovereign risk
out of Europe escalated, gold has barely risen, vs. the S&P TSX 60.
Why take the risk of a single asset vs. the Canadian equity market?
Chart 1
Furthermore, February 8th would seem to be a relevant date. Thus we
take a look from a different market, the FX market (which never lies).
This time, we wanted to look at the EUR/CAD cross. Indeed, this cross
moved significantly in CAD’s favor since February 8th , as shown in
Chart 2 below (source: Bloomberg):
Chart 2
But Chart 3 below (source: Bloomberg) provides us with a more fertile
conclusion. It shows the EUR/CAD cross (orange) vs. the CAD/USD
(white). It is very apparent to us that the shift out of the Euro and
into the CAD started at the end of November, immediately after the Dubai
credit event, and as rumors on Greece’s fiscal weakness were starting.
This move out of the Euro and into the CAD has been slow but sure! The
CAD/USD has been visibly more volatile, almost breaking the trend
(remember the resistance at 1.075 CAD/USD?)
Chart 3
We have consistently held that the strength in the CAD did not spill
over to Canadian assets, suggesting that it was driven by central banks’
reserve purchases. We believe this is now clearer than ever. Yesterday
also, with bearish oil inventory data, the Canadian dollar kept its
strength intact, touching 1.0275 CAD/USD intraday.
What to make of this?
Canada is receiving an important flow of capital. Going forward,
those mainstream economists (which we could also fairly brand as
“mercantilists”) that focus on commodities performance based on the
global recovery path to understand the Canadian story will be
disappointed. In our view, Canada is no longer just a commodity
exporter. Canada is now starting to export “peace of mind”, which the
world seems unable to find elsewhere. We made this prediction long ago,
when on June 2nd , 2009 wrote:
“… The Canadian dollar should remain within a free and flexible
exchange regime (including no further regulation on Canadian banks)”.
The stronger the intervention is, the weaker the Canadian dollar ends.
(…) Canadian stocks will not rise (as in the US), if the Bank of Canada
relaxes its monetary policy…Canadian stocks are rising because foreign
money is flowing in! And for foreign money to keep flowing in, Canada
must show it can provide a stable currency. The world is starving for
stability! All Canada needs to do is to remain quiet, while the rest of
the world misbehaves and voices its anti capitalistic rhetoric. In the
world of the blind, the one-eyed country gets the big bucks!…”
(“Meanwhile in Canada”, in: www.sibileau.com/martin/2009/06/02 )
We think this process in favor of Canada is in full force, unless
Parliament Hill derails it, which is always, always possible. Two days
ago, the Bank of Canada made clear (at least to us) that at the end of
its conditional commitment period, in June 2010, an upward revision of
policy rates will follow. This does nothing else but reinforce the
appreciation of things Canadian.
With these winds, we fail to see weakness in Canada’s real estate sector
and we want to be long Canadian equities, as they are driven by mining
in precious metals, basic resources and boring banks. Our propensity to
fear that slack in global growth will indirectly punish Canadian
valuations via lower commodities prices, is lower and lower, as the
world comes to Canada to deposit their savings in a safe place.
Martin Sibileau
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