Heading South? Converting to $US?

A client asked the question and since many clients may also want my opinion:

The $US is a very challenging topic for multiple reasons. There are greater minds than mine who all have opinions and I like to be on top of them, so I will break down the arguments for you.

First and foremost, despite what they may say publicly, the US administration under Obama want a weak $US to revive the US manufacturing and export sector. The consumer, historically 2/3 of the US economy, is not going to lead the recovery.

Also, while the growing economic powers are looking to move away from the $US as a reserve currency, that will take years to change.

But the market knows this and the large players in the foreign exchange world are already short $US.

The other side of the equation for you, of course, is the $Cda. The trend since 2003 has been towards a stronger $Cda (from the US 1.60 level to .96 pre meltdown).

The meltdown caused a flight away from risky assets and into $US, which took the $US/Cda back to 1.30. As the appetite for higher yielding and riskier assets came back and there were expectations of a stronger recovery for the Cdn economy, the $US/Cda improved to 1.02.

So basically that is, in a nutshell, the setting for thinking forward.

Predicting short-term fluctuations in currency movement is more technical than fundamental, but basically, right now it is a function of the risk trade, i.e. when capital market participants are willing to take on risk, equity markets rise and the $US/Cda will move towards parity (i.e. 1.00).

Also year-end is approaching and the holiday season, which has historically been favourable for the $US.

While the Global economy has still got considerable challenges, the appetite for risk going forward is a tricky call: There are significant amounts of liquidity in the system and this has forced investors into risk to get return, because the safe investments are yielding 0% (last week US T-bills auctioned at negative yields!). Arguably equity markets are ahead of themselves and a pull-back is not out of the question. A pull-back would entice a trade away from risk and likely force the $US higher. As foreign exchange participants are already short $US (and they may feel the pressure to buy in those positions as they get "offside"), that could add to a short-term $US rally which could get volatile with holiday and year-end liquidity drying up.

Longer-term, as economies recover, the liquidity will be withdrawn, but the timing on this is difficult. It may be 6 months or longer, depending on the recovery and how long it takes to get traction. The US will lag the rest of the world, because the consumer will not be participating. US housing and mortgage default issues are going to continue to be problematic well into 2010. So it is likely that the $US will continue to decline.

Also increasing demand for Cdn commodities from Asia will likely boost the $Cda and it will resume its upward trend, quite possibly beyond parity. As the Cdn economy out-performs the US economy, the Bank of Canada will start to drain liquidity sooner and interest rates in Canada may move up adding to demand for $Cda.

In summary, given the gradual recovery and Canada outperforming the US economically (I never like to underestimate the entrepreneurial spirit of the US, but their problems are deep and their government is as far left as any we've seen in since Roosevelt) I think the long-term play is to wait. Sorry for the long missive, but I wanted my arguments to be clear.

OCM diversifies across asset classes which means, ultimately, that you will likely hold between 15-25% $US in your portfolio, invested globally. You could always draw on this $US portion to avoid foreign exchange conversion hassles. One of the reasons OCM was able to keep volatility out of portfolios in the meltdown was that as equity markets crumbled in late 2008/early 2009, the $US soared and portfolio declines were mitigated.

Traditionally banks "rape and pillage" the consumer with surcharges of 4-5% (from the wholesale market) on currency transactions (inside info). We are much more competitive and I hate what the banks do, so rest assured, I will make sure that we are. Taryn (my associate) is well-trained in my thinking as we have a number of clients who "winter" south of the border and it is my fiduciary responsibility to ensure that they are not taken advantage of when they need to have their $Cda converted to $US.

Want to have a more thorough discussion? Call me, email me: jstomenson@wellwest.ca

www.jstomenson.ca