Loonie on its way up

Back in January when I made my fearless forecasts for what 2004 might hold in store, I said this about the prospects for our dollar, which closed 2003 at US77.13c:

“It would not surprise me to see our currency move back to the US75c range within a couple of months and then trade within a fairly narrow band of US74c to US76c through the rest of 2004.”

By and large, that’s exactly what happened until very recently. Now our dollar keeps pushing through the US77c mark in a clear effort to move higher.

So far, it hasn’t been able to stay there very long but the upward pressure on the loonie is clearly evident.

I have never claimed to be an expert on currency movements, which are notoriously unpredictable, but common sense suggests that our dollar is likely to continue to gather strength. There are several reasons for this.

· Fiscal responsibility. Despite the billions of dollars committed to health care last week, the federal government is in good financial shape. Stronger than expected economic growth has resulted in higher tax revenues and added to the anticipated 2004-05 surplus. With Paul Martin at e helm, we can feel comfortable that Ottawa’s finances will continue to be sound.

· The U.S. deficit. Compared to our situation, U.S. finances are in a mess. Their deficit is approaching $500 billion and could go much higher next year as Iraq continues to drain both blood and treasure. That will put increasing downward pressure on the greenback in currency markets.

· Strong commodity prices. Historically, the Canadian dollar has been strongest during periods when commodity prices were high. We are in such a period now and it appears that oil prices, for example, are likely to remain in the US$40+ range for some time to come.

· Corporate ability to adjust. Some Canadian companies and income trusts have seen reduced profits because of the rise of the loonie. But, overall, the business sector seems to have adjusted better and faster than anyone expected. Our trade surplus continues to be strong and managers for the most part appear to be meeting the challenge.

Could we see an 85-cent loonie?
All of this suggests that predictions of a US80c loonie in the not-too-distant future may well be on the mark, and perhaps even on the low side. We might see it move even higher (the US82c to US85c range is not out of reach by any means) by mid-2005, if there are no major changes in the fundamentals.

What does this mean to investors? A lot, if you invest in U.S. stocks. A rising loonie depresses profits from U.S.-dollar denominated securities, and this has to be factored in when you review your portfolio.

In 2003, the big jump in the value of the loonie (up 21.6 per cent) virtually wiped out the advances on Wall Street for Canadian investors. It is unlikely we will see currency gains of that magnitude in 2005, but it is equally unlikely that U.S. stocks will repeat the big advances of 2003.

This means that you need to be very selective in choosing your U.S. stocks and you may wish to reduce your exposure to them to some degree. For the time being at least, Canada looks like the right place to be.