Where’s shelter from falling loonie?

For some time, I’ve been warning the loonie was in danger of falling lower. I’ve urged people to hold a significant portion of their assets in other currencies, especially U.S. dollars.

In the first week of November, unfortunately, Canadian currency plunged through its all-time low and didn’t even stop to wave. By the time the carnage was over, it had dropped all the way to US$0.6261 before slightly rallying. 

Despite the rally at the end of November and the views of some economists that our currency is oversold, I fear there is still more downside risk here.

Loonie torpedoed
The loonie is being torpedoed by several factors, including:

• Low commodity prices
• World-wide recession fears
• The Argentina debt crisis
• The continued stampede to safe haven currencies like the U.S. dollar and the Swiss franc.

Some economists have warned we could see a US$0.60 loonie by year-end. That may be optimistic. The day when it takes two Canadian dollars to buy one U.S. greenback may not be far off.

Ways to diversify
In the past, I’ve suggested several ways to diversify into U.S. dlars.

• The simplest is to buy U.S. currency money market funds, although with interest rates so low the returns going forward will be very small.  
• Look for U.S. stocks  which have held up well in the market plunge. One example is Johnson & Johnson.
• Look at foreign bond funds, particularly those which do not hedge back into the Canadian dollar.

One recommendation in this last category is the GGOF Guardian RSP Foreign Income Fund.

It’s fully eligible for registered plans because it invests in foreign currency bonds issued by Canadian governments and corporations.

It also invests in bonds issued by supranational organizations approved by the department of Finance, such as the World Bank.

This fund has zero exposure to the loonie, which means it offers pure currency diversification into U.S. dollars, euros, etc.

Next page: Defensive positioning

Defensive positioning
Manager Laurence Linklater, of Dresdner RCM Global Investors, makes the currency calls based on economic conditions.

As of September 30th, (the last report available), the currency exposure was 59.4 per cent to the U.S. dollar, 30.4 per cent to the euro, and 10.2 per cent to the yen.

As of that date, slightly over half the assets of the fund (52 per cent) were in cash and short-term securities. The other 48 per cent was in bonds, so the overly positioning was highly defensive.

The fund has a very good track record with a one-year gain of 13.2 per cent (to September 30th ) and an average annual compound rate of return of 7.4 per cent over the past five years.

The gain year-to-date in 2001 is 11.6 per cent. However, year-to-year returns will be volatile.

Best, worst scenarios
This fund will perform best when two conditions prevail:

• A falling loonie
• Declining interest rates.

That’s exactly what we’ve seen in 2001. Conversely, a higher Canadian dollar combined with rising interest rates is a worst-case scenario here.

When I mentioned this fund to a broker a few weeks ago, with the loonie at around US$0.6375, the reply was: “Oh, I wouldn’t buy now with the Canadian dollar so low.”

Well, look what’s happened since. The fund went up 3.2 per cent in the month of October. How many mutual funds do you own that come anywhere close?

Turnaround possible
That said, I do not recommend this fund for someone looking for a currency speculation. The loonie could turn around strongly, and no one can predict when or if that might happen.

Rather, the fund should be treated strictly as a currency hedge. By adding it to your portfolio, you are diversifying some of your assets out of loonies and into other currencies.

That makes it a kind of insurance policy. If you lose a bit, treat it as the cost of an insurance premium. If you make some profit, as I think is quite possible in the next few months, that’s a bonus.

Year end considerations
Year-end is traditionally a weak period for our currency as foreign subsidiaries make dividend payments to parent firms and tourists exchange loonies for U.S. dollars and other currencies.

If those historic patterns continue, we could see the loonie drop below US$0.62 before New Year’s Day.

If you put any money into this fund, I recommend the Classic units because they carry a much lower MER, which significantly improves returns. However, they can only be purchased on a front-end load basis, so try to negotiate a minimal commission.

Adapted from the November 5th edition of the Internet Wealth Builder newsletter.