Why to short the Canadian Dollar

Discussion in 'Economics' started by scriabinop23, Nov 3, 2007.

  1. yes, another shameless brog promotion. But seriously, I'm very happy with this and wanted to share it with anyone interested. Feel free to visit and comment. (no snake oil to sell, just like the discussion)


    I am a contrarian by heart, and amidst the flushing of the US Dollar which has become the fashionable thing to do lately, I can't help but think several trading events are occurring structurally that give a clue that perhaps the US Dollar is not on its last legs. Not yet, at least.

    The primary tipoff is the strength in the 10 and 30 year note/bond. If the US Dollar was finished, no US dollar asset would be desireable, especially assets where value is entirely defined by yield. The long end would no longer be the preferred destination of flight to quality. 4.3% yields do not tell a story of lack of dollar hope, nor a hyperinflationary view. Trouble with particularly the US financial sector and worries of economic contagion supporting a flight to quality should not be supportive of the long end if the market view was of continued dollar devaluation (inflation pressure within the currency).

    Just as there are structural issues with the Chinese and Japanese in particular being net long end supporters and traditionally buoying the bond market with their reserves, a true dollar panic would certainly influence a sharp reversal in bond assets. An overly long market (by default due to its reserve status), just like stocks, would not have very much support at these levels. As evidenced in the August TICs report, the bond market was certainly supported amidst a the subprime meltdown by hedge funds and investment banks moving from stocks to treasuries, despite net selling by Asian treasuries holders:

    [chart ommitted]

    Fast forward three months later to the present, the long bond and 10 year note are at the same peak levels witnessed during the highest period of uncertainty, the day before the September 18th 50bps fed funds rate cut.

    Its quite possible China and Japan have been net exhaustive buyers of treasuries this past few months, in order to support their US denominated reserves amidst this flight away from the dollar. However I doubt their buying has been excessive, since almost every bullish treasury move seems dictated by lousy (for stock bulls) fear-induced equity selling climaxes. This looks to be the same buying by hedge funds, or as TICs data calls 'Carribean Banking Centers'. Obviously supported by the same flight to quality, I'm deducing this as a tell the US dollar is not finished. When US bonds sell off and yields rise to levels meant to match perceived dollar weakness and continued devaluation pressure, then finally the capital markets agree the dollar is done.

    With this as a core thesis, I am willing to conclude we are merely seeing is speculative money recklessly continuing to ride trends because they simply have been working. In the hedge fund universe, many billions of dollars can be shifted from equities and moved into the currencies and commodities (particularly crude, which is deeper than most others), as most equities are not perceived to offer a suitable risk/reward profile. TICs data from August reveals this type of movement from almost equal amounts of funds out of stocks and into bonds. That leaves plenty of cash to play with. Incidentally, the current free cash argument is embraced entirely by stock market bulls as a key reason to buy equities in this seasonally strong period. However, as banks are unveiling billions of dollars in losses on a daily basis amidst the obvious housing and possibly contagious consumer related credit crisis, why bet on equities when something else is out there?

    Right now, it could certainly be argued its easier to bet Dick Cheney will not handle Iran smoothly amidst a possible peak oil environment (continuously verified by declining North American production and seemingly vacuous information flow from key middle east OPEC producers as Saudi Arabia). Its also extremely fashionable to bet that because we had 2 FOMC rate cuts and have an extraordinarily ridiculous amount of debt to GDP, that Bernanke, Paulson, and Bush have no interest in keeping the dollar strong.

    Peak oil aside (which I argued for last year, only to see crude price collapse), arguing about whether crude is worth $100 or $70 is another issue, however. Fortunately for long crude position speculators, this runup occurred during a time of seasonal weak demand for gasoline and heating oil, primary byproducts of crude which traditionally guide demand for crude. These depressed crack spread margins have enabled a runup to occur without demand destruction to immediately become apparent. Now at $96 crude and with RBOB gasoline cracks widening back from $2 to $6 (note a $37 peak crack this spring), wholesale gasoline levels are back to all time highs. This may put a damper in the bull's optimism. Outside the US, Chinese are already rationing diesel. Demand is getting hit at these levels.

    Additionally, the Turkish/Kurd/Iraq conflict at most threatens 450K barrels/day of oil. With that seemingly neutralizing, OPEC has been additionally increasing output to meet demand.

    I see the price action in these markets as a giant trend of money flow into the same trade: Long crude, gold, Canadian dollar, short any USD, short US small caps (Russell 2K in particular, look at COT to see similar heavy short open interest), long NASDAQ (as tech is viewed relatively isolated from credit market issues), and long treasuries on bad US equities days. To reiterate, the short USD trade is not yet verified by the credit markets. 4.3% 10 year treasury yields do not agree with continued devaluation of the dollar.

    The Canadian dollar is a particularly interesting trade to take because it is a currency proxy for both US dollar weakness and Crude oil price, both which I view as being overdone and unconfirmed by treasury fundamentals. Here is the obvious correlation.

    CFTC COT (Link Here) reports reveal an 8:1 speculative long versus short position in the Canadian dollar as evidenced below:

    [cot data ommitted]

    Right now this type of lopsided open interest is paralleled in many short USD trades, particularly in the commodity currencies such as the AUD. It tells me its very one sided, very driven and protected, and that its prone to a sharp correction when all of the speculative funds find something else to be interested in (most likely equities when these banks stop releasing such horrid news).

    The obvious question is of course how far will the bulls take it? Perhaps $100 crude and 1.10 CAD, but the upside of a potential reversal and resulting long liquidation (and not enough short interest to keep covering as price supportive) makes it worth shorting both. I am short at 1.07 CADZ07 (December 07 futures), and think a move back to parity is likely. I may exit and re-enter intermediately to manage this entry, but its a trade I intend to press when it starts working.

    A short treasury position here may also be advisable. When and if a genuine dollar panic ensued, or simply if speculative funds became tired of long commodities, short equities, long flight to quality, treasuries will be in excellent position to sell off.
  2. I think your making a foolhardy play, here's the best example I can give you.

    What Canada has going for them?
    -Loved by every country in the world, Americans put Canadian flags on their backpacks in Europe
    -Commodity based market, OIL, Gold, Copper, were providing the next superpowers with the keys to building their infrastructure
    -A Healthy economy, where surpluses are produced every year and the deficit is going down.

    What does America have for them?
    -Social Networking

    Honestly, I dont see anything that America has going for them, how about some of these factors?

    -The worlds debtor nation
    -The Americans no longer produce the worlds major and key ideas
    -The NYSE's major winners the past 5 years have been adrs
    -A war that will never go away
    -No oil.
  3. I predict the 1 USD will be .75 Canadian by Next year around June.

    To All the American traders, switch your money to Canadian!

  4. This might be a good idea as I might illustrate on data from one forex retail platform :

    According to their real-time survey on the positioning of more than 20.000 retail traders nearly 78% of traders are long USD / CAD. This works as an contrarian indicator and signals more USD /CAD losses.
  5. GaryN


    Where do you get this information?
  6. sim03


    ASusilovic is talking about FXCM Speculative Sentiment Index (SSI). If you have an FXCM account, you get access to twice-daily updates. If you don't have one, you can see SSI weekly updates and commentary on DailyFX (RSS feed available):


    If you are going to delve into this, note that Oanda publishes 4 different but complementary tools on the positioning of its traders, updated hourly, 24/7:


    Besides open positions and ratios, you also get historical views and even currently pending orders.
  7. plugger


    Hi Scri:

    A Cdn dollar short is a very tough trade to call. From a Cdn's perspective, here are some things you may wish to consider also:

    (a) the Cdn government has been running very large budget surpluses. This year it will clock in around $13 billion. Positive.

    (b) on Tuesday, the Cdn government gave a budget update. In it, they cut our national sales tax and accelerated corporate tax cuts. By 2011, Canada will have the lowest corporate taxes in the G8. Positive

    (c) On Friday, our unemployment report was released showing a net gain of 66 thousand new jobs. By comparison, the U.S. only created 166 thousand new jobs. By a factor of 10, we should have expected job creation in the U.S. to hit 660 thousand. Canada's job growth is outpacing the U.S. Positive.

    (d) Wage gains in Canada were +4.1% year over year. The strongest wage gains in over a decade. Positive.

    (e) the Bank of Canada is one of the only central banks in the world that has an explicit inflation rate target, 1-3%. It's been in place since 1991. The BOC's mandate is to keep inflation in check, unlike the Federal Reserve who can pick whatever goal it wishes to achieve. Positive.

    (f) there is considerable pressure on the BOC to raise rates to control inflation. On the other hand, the U.S. is now in lowering mode. The interest rate differential will grow. Positive.

    (g) Provincial governments are also enjoying fiscal surpluses which they have been using to provide additional tax cuts. Positive.

    (h) the Cdn dollar is truly viewed as a commodity currency. Until oil breaks and other commodities fall, it should be supportive of the Cdn dollar. Our terms of trade have improved considerably, what Canada sells is in great demand. Positive.

    (i) agricultural commodities are ramping up. Positive.

    While the rise in the Cdn dollar has been very swift, there seems to be considerable underlying strength.

    I'm sure there will be a very nice countertrend move at some point (I've tried trading for this one), but when does it start? Maybe it its $1.10 U.S. before a reversal happens.

    Just some food for thought.
  8. Cutten


    The reason to short the Canadian dollar is if you think the US dollar is close to a short/medium-term bounce of 10% or so. Any short-term movement in the currency will most likely have nothing to do with Canada or any fundamentals - just a pure technical reaction.
  9. Here is the only meaningful prediction no matter what anyone "thinks is going to happen".

    If the price flow keeps going down, then sell. If it stops going down then cover.

    If the price flow starts to flow up, then buy. If it stops going up then exit.

    Who really cares what everyone thinks?
  10. So would you buy BIDU, buy the CAD, and short MER and C here?
    #10     Nov 3, 2007