Article Series
The Arctic Cold War Looming
The Uranium Merger Mania Pending
The Paradigm Behind Global Trade Protectionism
The Stealth Rally in Mining Mergers
Special Memorial Day Weekend Report
Special Report
The Paradigm Shift of Sky-High Oil
Special Report: Commodities and North Ameria
By George Bell
With oil and commodities on the rise, here’s what investors need to know about Canada and the U.S.
Looking into the present state of affairs within declining global GDP and the troublesome U.S. economy, it’s no wonder Foreign Exchange Markets (FOREX) have seen wild fluctuations in many currencies over the past few weeks. The simple fact of the matter is both the U.S. and Euro Zone policy makers are torn between whether their economies are headed for long-term trouble, or have just “hit the skids” temporarily.
In early April, 2008 the International Monetary Fund revised 2008 global GDP downward to 3.6% from 4.1%, while slashing the United State’s full year outlook from 1.5% to 0.6%. Moreover, the IMF also lowered 2008 Euro area GDP from 1.6% to 1.4%. Clearly, the aforementioned paints a dismal picture for the Euro area and U.S.
At the same time, the IMF also predicts Canada’s real GDP for 2008 will finish the year at 1.3%, with 2009 at 1.9%. It’s true that healthy advanced economy growth rates tend to fall in the 2.0% to 2.5% range. Some may be wondering why the significantly large distinction between Canada’s GDP growth expectations and that of the U.S., especially when considering the two countries sit side by side.
Intuitively one might think the GDP growth rates should be similar; however, digging under the surface (literally), a slight different picture appears.
Foremost, the decline in the U.S. dollar has helped spur a global commodity rally, something that is helping bolster Canada’s economy as well.
Canada and the U.S. Helping One Another
While the larger global GDP environment shows signs of weakness across the board, U.S. investors may be wondering what the present commodities rally means to the U.S. and its neighbor to the North.
First and foremost, it’s important to note that whenever the U.S. economy does well, typically, so does the Canadian economy. Over the past year, the U.S. economy has certainly stumbled and globally many are seeing a continued weakening environment. However, recent signs in the economy of the U.S. are actually showing signs of improvement, albeit no faster than cold molasses.
U.S. economic improvements include:
1. A potential revision of 1st Quarter GDP growth from 0.6% to 1.0%
2. Real estate markets showing some very faint signs of bottoming, including that of the 40.3% growth in multi-family home starts in the past week.
3. Stalling job losses.
4. ECRI Leading indicators showing strength since the first week of April.
5. The FOMC’s commitment to maintaining liquidity within U.S. credit markets.
Of course, the main drags on the U.S. economy - at present - are rising oil and commodity prices; however, as you will soon see, these issues could abate in the months to come.
Before we get to commodities and oil, though, let’s consider Canada slightly more. Overall, Canada has been fortunate enough to maintain moderate growth thus far in 2008 and will likely do so throughout the remainder of the year. Much of this is due to the fact that the Canadian government continues to supply jobs within the market, as seen in the unemployment just barely off 33-year lows.
Taking cues from the U.S. though, the Bank of Canada has been quick to lower interest rates, so as to starve off the possibility of credit contraction. This is seen in the April 22 cut from 3.5% to 3.0%, with the BOC having now cut 150 basis points since December of 2007.
Currencies and Commodities
As many may well already know, currencies and commodities go hand in hand, especially when considering the tight relationship of the U.S. dollar to oil. However, in recent weeks, the U.S. dollar has again begun to approach lows, due to oil running to stratospheric levels. What is really happening here is this:
OPEC is not budging to increase supply, or hold an emergency meeting, before the regularly scheduled September event. Though Saudi Arabia has agreed to begin supplying 300,000 additional barrels of oil in June, the occurrence won’t likely make too much of a difference.
Oil and the U.S. dollar have a cyclical relationship, when the U.S. dollar declines, oil rallies and vice versa.
Commodity prices will likely continue to stay strong until the U.S. reconsiders the current 54-cent per gallon tariff on Brazilian sugarcane ethanol. The tariff is set to expire on Dec. 31, 2008; however, there is already a movement on Capital Hill to extend the tax out until 2011.
The bottom line is that because oil remains high, and commodities are showing no signs of abating, the above translates to more weakness for the U.S. dollar.
What Does it All Mean?
At the end of the day, until something changes in the larger oil story, the U.S. economy could continue to struggle in the present environment. The aforementioned also means the U.S. dollar will have trouble gaining ground. Of course, if the dollar breaks lows, investors may want to start looking for capitulatory prices in oil, perhaps even at, or above, $150 a barrel. I hate to say it, but the declining dollar environment, coupled with rising oil prices, means the loonie may actually gain ground, benefiting from the commodity-backed economy of Canada.
While the loonie is already showing signs of overvaluation -- potentially meaning a correction is in the wings in the months to come -- Canada’s stability of GDP growth could be a great place for U.S. investors to hedge their investments, at least in the short-term.
Over the long haul the U.S. economy will rebound, and the Canadian economy will equally benefit from such, something that’s a perk of being such close neighbors with an open trade policy.
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