The Canadian dollar has dropped about 7.5% against the U.S. dollar since the end of September. In the developed currency markets, that’s a pretty big move.
Currency markets are in a state of flux, driven by the gradual change in direction of the U.S. Fed’s monetary policy; increased stresses in emerging markets; and capital flows back to the U.S. thanks to higher yields and strong equity markets, among others. It’s a bumpy road, and biggest bumps are being felt in emerging market currencies like the Turkish lira—down 30% over the past year—and the 25% drop in the Indonesian Rupiah.
The Canadian dollar is down not just against the greenback but against most other major currencies. Over the past three months the Canadian dollar has declined 6%, 5% and 8% against the U.S. dollar, euro and British pound respectively. So what does that mean for investors?
There are winners and losers when currencies move. The obvious beneficiaries are holdings denominated in these other currencies, like your U.S. holdings. But it goes much beyond that. Some Canadian companies benefit and some lose from a falling loonie.
Winners: Companies that sell in U.S. dollars and have Canadian dollar expenses. The oil patch certainly fits the bill, notably domestic producers. Other resource companies benefit as well, depending on where operations are located and their cost structures. Of course, one problem is commodities will decline in value as the U.S. dollar rises, so this partially reduces the benefit.
Some manufacturing companies in Canada benefit thanks to international sales. However, there really aren’t that many manufacturing companies left in Canada. Then there are companies with international operations. While these likely have both international sales and costs, profits are worth more when converted back to Canadian dollars. A good contrast would be TD Bank, with one quarter of sales outside Canada, and National Bank, which is almost 100% Canadian. While the currency move won’t hurt National, it should benefit TD.
Losers: Companies that import or have to buy inputs in foreign currency to sell in Canada. Retailers are exposed, depending on where their goods are located. If they’re in the U.S. or Europe, it’s a problem. If in emerging economies—most textiles for instance—they may be somewhat shielded because currencies in emerging economies are dropping even faster.
With big currency moves such as these, taking note of where companies operate and how those operations are translated back to financial results will become a more important factor in the quarters ahead.
QUESTION OF THE WEEK
The price differential between West Texas Intermediate (WTI) oil and North Sea Brent oil has been falling in recent weeks, is this trend likely to continue or reverse?
There has been a significant reduction in oil inventories and pipeline blockages in the U.S. since the beginning of the winter. This has translated into cheaper oil and gasoline prices and might be the first sign that the shale revolution occurring in the U.S. is finally lowering prices at the pumps.
Until recently, the increase in U.S. domestic production has not translated in cost savings for the common consumer. Pipelines have limited capacity, so there have been issues transporting this new glut of oil to refiners on the coast. This has caused a dramatic increase in transportation of oil by rail and truck; but still, the increase has not kept up with growing supply. Much of this supply glut has been sitting in holding tanks near Cushing Oklahoma, where the WTI price is set.
Without access to the cheaper WTI oil, refiners on the coast are forced to pay seaborne Brent prices, which until recently have been trading at nearly a $20 premium to WTI. This trend has now reversed as increased pipeline capacity has come on board. Yesterday, TransCanada’s Keystone South pipeline started pumping 288,000 barrels a day (BoD) from Cushing to the coast. The pipeline is expected to increase capacity to 700,000 BoD by the end of the year. On top of that, Enbridge’s Seaway pipeline has plans to double its capacity to 850,000 BoD by the start of 2015.
This trend has put pressure on global suppliers shipping oil to the U.S. Gulf Coast. These primarily African OPEC suppliers have been forced to begin selling to U.S. refiners at a discount to global prices in an attempt to maintain their market share. Eventually OPEC suppliers will divert those shipments to Asia and Europe, flooding the market with increased supply. This will be occurring concurrently as sanctions against Iran are eased and they increase their production output. All of this would likely lead to a further reduction in global prices and a tightening in the spread between WTI and Brent.