Newsletter November 3, 2007

InvestorsFriend Inc. Newsletter November 3, 2007

Canadian dollar at $1.07 is a National Economic Emergency?

Canada’s dollar has soared 25% against the American dollar in 2007 alone, from U.S. 85.8 cents to $1.07. Dianne Francis in today’s Financial Post called this an emergency. I agree, it is a national economic emergency!

Now it is true that at the end of 2006 the Canadian dollar was already up by about 35% from its absolute lows down around 62 cents and the economy did not seem to suffer from that rise. But remember, Canada’s dollar was only below 68 cents relatively briefly.

Arguably Canada could adjust reasonably well to a dollar that rose from the approximate 70 cent level where it has spent a number of years to the 80 cent level. But it has been decades since Canada’s dollar was over 90 cents and this recent $1.07 level is a new record. After decades of operating with a dollar well under 90 cents (and often closer to 70 cents), this sharp rise to $1.07 will have dire consequences if it is not soon reversed.

The Canadian Economy

A high Canadian dollar is very good for importers and very bad for exporters. In order to understand the impact of a high dollar, it is first necessary to understand Canada’s economy.

Manufacturing and exports of manufactured goods still accounts for a surprisingly large share of Canada’s economy. In our new article on the Understanding the Canadian Economy we show you the key facts. We show you the percentage of GDP that various industries make up. Prepare to be surprised.

Why does a high Canadian dollar hurt many Canadian businesses?

Consider a Canadian manufacturer that exports most of its production to the United States.

The revenue that this Canadian manufacturer receives was worth CAN $1.17 per U.S. dollar at the start of this year. Now the same U.S. dollar is worth only CAN $0.93. This is equivalent to a 20% price cut. Unless this manufacture was making a profit margin of over 20% (which seems doubtful) then this manufacture would now be losing money.

And for quite a few years when the Canadian dollar was worth 70 cents or a bit less, so this Canadian manufacturer was receiving CAN $1.43 for each U.S. dollar. So the full price cut since 2003 has been about 50 cents (1.43 minus 0.93) or 35%.

If manufacturers selling into the United States have taken a 35% price cut in just a few years, then it’s plain to see that many of them will go bankrupt as a result. Many jobs will be lost.

But Can’t these manufactures “adjust” to the higher dollar?
Often they can’t raise their prices in the U.S. because they are competing with America companies for whom a U.S. dollar is still worth a dollar.

They could, in theory, adjust by “simply” cutting their wage rates and all other costs by 35%. Does that sound even remotely realistic?

They can also become more productive by buying new machinery and technology. And the good news is this machinery is often from the United States and is now cheaper. The bad news is it may be awfully hard to buy this machinery now that so many manufactures are now probably losing money.

What about Canadian manufactures that sell only in Canada?

These manufactures are not hit as hard. But they now face the threat of cheap imports. A $100 U.S. product that cost CAN $143 a few years ago at the 70 cent exchange rate now costs $93. Why should Canadian customers keep buying from Canadian manufactures when they have been handed a 35% reduction in the price of American goods?

But isn’t manufacturing now only a small part of Canada’s economy?

No! it’s not. Manufacturing still accounts for a huge 15% of the Canadian GDP. That is actually far larger than oil, gas and minerals combined. Manufacturing accounts for a staggering 45% of Canada’s exports. See our new article on Understanding the Canadian Economy.

Can’t Canada just sell its manufactured goods to other Countries?

Many Canadians take some pleasure in seeing the drop in the U.S. dollar. It might be nice to conclude that the United States is fading in its position as the world’s largest economy. And in the long term that is probably true. But meanwhile Canada sells a staggering 79% of its exports to the United States. If Canada’s products become uncompetitive in the U.S., there is no realistic way to replace that market. Canada is obviously closely linked to the U.S. by geography and (as much as Canadians hate to admit it) by culture. The United States will be the largest trading partner of Canada probably virtually forever. There is no getting around that.

Also the Canadian dollar has also risen substantially against most world currencies and so the high dollar issue applies on the world stage as well, although to a smaller degree.

But aren’t the job figures still good, proving the dollar is not a problem?

Yes, the latest job figures are excellent. Unemployment is at record lows. But remember, the impact of the really high dollar has not worked through the system yet. The dollar only passed parity with the U.S. about one month ago. It has been only six months since the Canadian dollar was under 90 cents.

Remember, it will take some time to close most of the car plants in Canada. It will take time before the Alberta “oil patch” starts sourcing its machine shop work from the U.S. rather than Canada. It takes time before we notice that Canadians are vacationing less in Canada and more in the U.S. and that American tourists are staying away from Canada in droves. It takes time before Canadians demand all prices drop to the U.S. level. It takes time before Canadian retailers figure out that many of their customers are now ordering their cloths, computers and many other goods from the U.S. You can bet that every Canadian customer that buys manufactured goods is now looking at the savings available by buying from the U.S. Canadian retailers are quickly pressuring their wholesalers to drop prices. But there are contracts in place and inventory was often purchased some months ago. So the effect is not immediate. But it will come.

The latest strong job figures showed that it was mostly government and government-related that was hiring. That is not exactly comforting.

The dollar has moved way too fast for the statistics to keep up. In the months ahead we will quickly see the disaster that surely awaits for manufacturers if the Canadian dollar does not come down very soon to the 90 cent level.

For the government this should be considered a national emergency.

For Canadians employed by a company that is competing with U.S. costs, this is a personal emergency.

For Canadian Investors, portfolios should be reviewed on an emergency basis.

What about Jobs?

Canadian exports are less competitive in the U.S. market to the tune of 20% this year and 35% over the past few years. American imports conversely are 20% cheaper in Canada than they were at the start of 2007 and some 35% cheaper than they were a few years.

This equation clearly suggests Canada’s imports will rise and its exports will fall. In effect jobs will clearly be shifted to the united States.

Well, at least if you have to move to the U.S. (for a job) your savings are worth a lot more there.

Rather Than an Emergency, Doesn’t the High Dollar simply reflect Canada’s success?

Partly it does yes. The dollar has risen partly because of Canada’s rich reserves of oil and gas. And also because of Canada’s strong economy and lower national debt.

But rather than crowing about these successes, Canada now needs to quickly understand what damage might be caused and needs to move quickly to prevent such damage.

What should Canadian Investors do?

Firstly, almost all Canadians in a position to do so should consider putting a material portion of their investments into U.S. dollars if they have not already done so. Most Canadians will at some point need U.S. dollars for vacations, purchases from the U.S. or spending winters in the U.S. It makes sense to hedge that future expense by moving some savings into U.S. dollars now.

And yes, that has been a losing strategy for the past five years. Sometimes a good decision (diversifying into U.S. assets) turns out bad.

If you think that buying U.S. dollars is a bad idea because the Canadian dollar is going to continue to rise, then I think you have to be able to convince yourself that the Canadian economy can withstand such a sharp rise in the dollar.

At this point the Canadian dollar still seems to have momentum and could go higher. But it is already far higher than anyone ever predicted. U.S. dollars are cheaper than almost anyone would have predicted.  It’s entirely possible that the high dollar will soon brake the back of the Canadian economy which would cause the Canadian dollar to fall. Therefore, it remains a good decision to move money into U.S. dollars. This does not have to be into U.S. stocks. This can be a simple U.S. dollar savings account. In the case of RRSP money a U.S. dollar money market fund can be used.

It seems fairly predictable that certain Canadian companies will be hurt badly. To some extent this has already happened. But the most recent surge in the dollar has certainly not hit the financials statements yet. Therefore many Canadian stocks likely have much further to fall if the dollar stays at $1.07 or anything close to that.

It seems wise to consider selling any Canadian company that produces a competitive product or service in Canada but sells that product outside of Canada. Bombardier certainly comes to mind. Almost all Canadian manufacturers are suspect at this time. Even if they sell their products in Canada they now face new competition. Consider selling shares in any Canadian manufacturer that you hold.

Companies that are headquartered in Canada but which have most of their revenues and expenses outside of Canada are also suspect. The profits that they bring back to Canada will not be as high with the higher dollar.

Subscribers to our Stock Picks have been and will continue to be aware of exactly which stocks we are selling.

What should Canadian Consumers Do?

Individual consumers should act in their own best interest. This means using internet and mail order to shop in the U.S. Demanding that stores lower prices to the U.S. level. Take advantage of cheaper travel to the U.S. Delay the purchase of cars and major items until the prices drop.

Capitalism works by each person acting in their own best interest. If the Canadian dollar needs to fall, it is up to Government to do that. Canadian manufacturers should not expect any special support from Canadian consumers. Sorry, but that is how it works.

When it comes to war, Canadians have a duty to their county. When it comes to economics their duty is only to their own family members.


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Shawn Allen, President
InvestorsFriend Inc.

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