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We are adopting a bearish stance on the Invesco CurrencyShares Canadian Dollar Trust (FXC), which is an ETF that seeks to track the closing spot price of the Canadian Dollar (CAD) in USD. We expect the ETF to decline to a price of around USD 71.77 in the next one year on the back of global economic slowdown and trade tensions with the US. We advise investors to reduce exposure to FXC, and to start accumulating if its price falls below USD 68.35, which is 5% below our target price. The chart below shows our base, worse and better case forecasts for CAD per USD.
CAD Appears Most Affected By Trade Balance
In order to create an econometric model for forecasting Canadian Dollar we ran a regression of the CAD against several factors, namely (i) GDP differential between USA and Canada, (ii) inflation rate differential between USA and Canada, (iii) interest rate differential between USA and Canada, (iv) real interest rate differential between USA and Canada, and (v) Canada’s current account balance. However, with the exception of the current account balance, we could not conclude that any of the variables were statistically significant in explaining the movement in the Canadian Dollar. The p-values from our regression analysis are given below. (Please note that a p-value of less than 0.05 is needed to reject our null hypothesis that the CAD does not depend on the independent variables. In other words, a lower than 0.05 p-value means that the variable is significantly affecting CAD).
Within the current account balance we found that CAD was dependent on Canada’s overall trade balance and trade balance with the US, as can be seen from the summary regression output below (please note that the p-values for both are below 0.05).
However, we have decided to NOT base our forecast on an econometric model using the trade balance variables because the R squared, a goodness of fit measure, is only 18.6%. In simpler words, the trade balances do not do a good enough job of explaining the movement in CAD.
Consequently, instead of basing our forecast on an econometric model, we have based it on qualitative analysis of the trade balance and our outlook on the same.
Tame Global Economic Growth Outlook Bodes Ill For FXC
Trade tensions between the biggest economies of the world and Brexit are likely to restrain global economic growth in the next twelve months. In fact, in its latest economic outlook report, the IMF projected the world economy to grow only 3.3% in 2019, which is the weakest since 2009 when the world economy shrank. Due to our weak global economic outlook, we expect global oil prices to decline in the next one year. As energy exports make up around 25% of Canada’s goods exports, weakness in oil prices will translate into deterioration of Canada’s trade balance. As a result, we expect Canada’s trade deficit (against all countries combined) to widen in the next one year. The widening of trade deficit will lead to further depreciation of the CAD, as reflected in our base case forecast.
Tariff Threats And Uncertainties To Also Drag FXC
The US Administration’s latest tariffs threats to Mexico show that even after the USMCA (replacement for NAFTA) is ratified by the three countries, trade tensions will not die down due to the ongoing geopolitical tensions. To recall, on May 31, the US president threatened to impose a 5% tariff on all goods imported from Mexico starting June 10, and to take that tariff level up to 25% by October 1 in a staggered manner.
The chart below shows how the Canadian Dollar responds immediately to geopolitical developments that affect Canada’s trade agreement with the US and Mexico, and consequently Canada’s trade balance. Events that negatively affected outlook on the trilateral trade agreement are given in red, while events that positively affected it are given in green font colour. As can be seen from the chart, CAD used to be very sensitive to geopolitics and the trade agreement with its biggest partners (see the first five events in the chart below) earlier, but in the last one year it has become less responsive to developments in Canada’s trade agreement. Despite two positive events, the CAD continued depreciating against the USD, as seen in the shaded part of the chart below.
Advising Reduction Of Exposure To FXC
After considering the factors that can affect CAD in the next one year, we have reached the conclusion that CAD is likely to depreciate further. We expect a 3% depreciation in the next one year, which is not as extreme as 2015 when CAD depreciated by 14% on the back of the oil price decline, but is higher than the 0.3% depreciation witnessed in 2018. Consequently, we expect CAD to depreciate to USD 0.7177. As FXC tracks the closing spot price of CAD, we expect FXC’s price to decline to around USD 71.77 up to June 2020. Therefore, we advise investors who are already holding FXC to reduce their exposure. We are also advising investors to accumulate FXC if its price falls below USD 68.35, which is 5% below our target price.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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