Via Kevin Muir of “The Macro Tourist” fame
Late last month I got bearish on the Canadian currency (Tough Day to be Canadian). It has been a modest winner, but given last week’s decimation in the commodity sector, along with crude oil’s collapse, I am surprised it hasn’t been a better trade. Even as the bad news out of the Canadian embattled sub-prime alternative home lender, Home Capital Group, has continued, the Loonie’s decline has refused to accelerate.
What has me worried is that this seems to be a perfect storm of bad news for Canada, yet the currency is hanging in there.
Then, when I turn on TV and see interviews like this, my antennae perks up:
I like Gary and he seems like an agreeable enough fellow, but he is a huge deflationist that is forever forecasting the coming collapse in all prices, except treasury bonds. Not taking anything away from him, as he was early (and correct), in understanding the dis-inflationary forces that are now hampering the global financial system, but when he gets too much airplay, you know the short term trend is getting long in the tooth. I distinctly remember the last time his face filled the airwaves, it was when oil was under $30 and Gary was getting all sorts of publicity for his bold $10 oil call. His most viewed interview was probably right at the bottom.
Right now, amongst the hot money crowd, it is fashionable to be short Canadian dollars. It was only two months ago they were all betting on global reflation lifting Canadian assets, but since then, the bloom has come off the rose, and now China collapse / Trump disappointment has become the dominant themes.
When you throw in the problems with Home Capital Group, Canada’s troubled alternative sub-prime home lender, it is easy to see why shorting the Loonie became a hedge fund favourite.
I don’t know if it was too many adolescent years not being part of the cool crowd (too much Dungeons & Dragons along with hands like stones when I picked up a hockey stick), but I am uncomfortable whenever too many hedgies agree with my position. Yeah, I know, sometimes I should just sit back and enjoy the ride as they push the trade to extremes, but in this case, I feel better on the sidelines.
I am doubtful the Home Capital Group chaos is systemic to the Canadian financial system like many of these aggressive hedge funds believe. Heck, I even wonder if their problems were even remotely as serious as the bears claim. With nightmares of 2008 still lingering in their minds of investors, it doesn’t take much to scare away short term funding for financial companies. Although I am sure there were some improprieties at HCG, I suspect their biggest crime was relying too much on non-sticky short term money. Do I think Canadian real estate is overvalued and due for a correction? You betcha! Do I think it will be a repeat of the US 2008 crisis? Doubtful.
I worry that these sorts of horror movie housing collapse bear market scenarios are being built into the price of the Canadian dollar.
Yet, after droning on about sentiment and anecdotal observations about Canadian real estate, let me present the following charts that might make you question whether any of this even matters.
First up, here is CADUSD (the opposite of what FX traders usually use, so lower means weaker Loonie) vs. the spread between the US and Canadian 2 year government yield:
Either US rates are too high, Canadian rates too low, or the Loonie should be lower. That certainly seems to support the CAD bears’ thesis.
But then let’s have a look at the other big driver of the Canadian dollar – oil.
There is no denying that the Loonie is a petro-currency. Instead of trading CAD, you might as well just trade WTI.
Yet this correlation is showing the Loonie undervalued versus crude oil. Could the recent Loonie’s larger decline versus oil be the result of the Home Capital Group worries?
Before you run with that theory, let’s replace spot crude with the one year forward contract. The correlation between the two assets becomes even tighter.
And in this case, CAD is fairly priced.
So we have one chart that shows CAD overpriced, one underpriced, and one fairly priced. Doesn’t really help us that much, except to note that maybe all this other analysis is bullshit, and instead we should just focus on crude oil and interest rates.
Yet, all these hedge funds are betting on a weaker Loonie based on the coming collapse of the Canadian real estate market.
Well, that’s it for me. I have covered my CAD shorts. If oil stops declining, and the HCG funding problem stabilizes enough to take it off the front page, we could see all these hedge funds run for cover.
Now maybe I am leaving the trade just before it is about to accelerate. So be it, I will live with that possibility. All I know is that I no longer want to be short with them. I don’t have any concrete reasons for not sticking with the short, just a spidey sense that when the bad news storm rolls in, and the price doesn’t collapse, maybe it is time to get out.
