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Oil, and Economy

By: Stew Mayers The C$ will decline
March 2005

The high price of Oil at well over $55 per barrel, is still only 60 % of all-time highs reached in the early 1980s. Oil prices should decline to less than $40 per barrel during 2005. Since the increased value in the C$ is predicated on rising commodity prices – especially oil, gas and coal – a decline in oil prices and a rise in US interest rates should reverse the C $’s rise. Oil prices are rising mostly due to the weakness in the US$ since oil is priced in US$. Oil Supply still outstrips demand, and large oil projects and increased production will ensure that demand does not outpace supply.

Investors keep selling off U.S. dollars as the market continues to be concerned about U.S. trade data, which could reinforce fears over the U.S. current account deficit, which has reached record high levels. "(The) catalyst seems to be concern about trade data… whether it's going to continue to show a large U.S. trade deficit (and) thus a need for the U.S. dollar to move lower," states Paul Ferley, assistant chief economist at Bank of Montreal.

It is hard to reconcile such analysis with reality. The US has usually run trade deficits, oftentimes quite a bit larger as a % of GDP, throughout its history. The current US Trade deficit has no actual influence on the economy – it counts for 0.5 % of the US economy and simply means that the US savings rate is less than investment, and that the US economy is growing faster and thus importing more than anywhere else in the world. During the 1990s the US $ increased in value though it ran a trade deficit every year barring 1992. The US is attracting capital and product. This is the sign of an economy that is growing, has high returns and high disposable income.

Regarding the C$, it is now a Petro-currency. Crude oil is one of Canada's main exports and is probably the primary reason for the Canadian dollar's strength. Oil represents 35 percent of Canada's exports and exports accounts for 10 percent of Canadian GDP. As Oil prices surge it is expected that the C$ will rise. However in the medium term the price of oil should fall due to increased supply, reduced demand as we move into spring and summer, and reduced Chinese and Indian strategic reserve buying. There are many who contend that Indian and Chinese demand will decline as their economies cool, and that their strategic reserve buying will necessarily be curtailed due to high current prices. As oil prices decline the C$ will fall to well below 80 cents US.

Besides decreasing Oil prices, the C$ will fall due to higher US interest rates. The U.S. Fed will likely decide to raise its benchmark rate in late March and most economists expect the Fed rate to rise from 2.5 % to 3.5% during 2005. The U.S. and Canada currently have the same rates, but a hike in the U.S. benchmark rate may encourage investors to shift their money from Canadian to US debt instruments. This increased demand for US$, coupled with a stricter money supply, weaker Canadian economic growth vs. the US, and weaker real private sector job creation in Canada, should mean a sell-off of the C$. The US economy is growing at 2x the Canadian rate, with real job growth [not public sector hiring] and a 3-4 % productivity level vs. a non-existent Canadian productivity rate. This will ensure higher US economic growth and allocation of investments from the C$ to the US$.

As long as Canada taxes and spends more than Americans, there will never be a reason to hold C$ in lieu of U$, unless you are betting on commodity price increases. Unless Canada reforms its investment, tax and various factors which impact productivity, its dollar is destined to trade at a sizeable discount to the US$.
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For a view on why the US$ will decline in 2005 and the C$ remain above 80 cents see the TD Banks’s report
http://www.newswire.ca/en/releases/archive/December2004/09/c2503.html

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After working for a few large IT firms Read born in 1966, is currently an entrepreneur and Venture Capital Advisor and Managing Consultant for Wireless and Mobile technologies [including the internet] and in particular, in software applications for the Wireless or Mobile Industry. www.craigread.com/ RESOURCE: www.craigread.com/displayArticle.aspx?contentID=86&subgroupID=21

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