Monday, November 12, 2007

Loonie Tunes...

I first heard about the TarSands, courtesy the ever generous Leigh Shankland. He was super excited about it, but I was in highschool and I had other things to be excited about. The latest NewYorker has an wholesome piece about the TarSands in Alberta. It deals with the energy costs in producing a barrel of oil (around 1/3 a barrel! -- without dipping into the subtleties...); the environmental impacts (pollution, cancer) and the GoldRush spirit at work that trampels most voices. There are clear reasons why this phenomenon will last. Extracting oil from tarsands costs between 30-40USD per barrel, around 174 billion barrels of recoverable oil, etc etc., While reading, it is clear that this phenomenon is here to stay -- over the next 30-50 years. And to some extent, it is suffice to say that the TarSands are only getting started -- there are other firms coming into the mining industry, firms keen on supplying energy to the mining firms, firms that are laying pipelines and so on and so forth. Over 3/4th of a percentge of Canadian GDP is expected to be spent in 2008. It is fair to say, I think, before the lifetime of most readers of this note the long term impact of the TarSands -- environmentally and in raising global supply of oil is dramatic.

One area where the effects are demonstrably clear is the exchange rate. Rising investments in the TarSands coupled with rising commodity costs -- causes increased profitability of Canadian firms. The financial herd comes chasing the possibility of a superior return which puts an upward pressure on the CAD. On top, the speculative capital anticipating this upward pressure on the CAD follows through as well, hoping for a quick turn around before month end P&L numbers are issued. There is the obvious sense that the rising CAD affects other Canadian exports -- and to a reasonable degree this is true. However, the rising CAD affects, in the short term, only those purchases made on the margin (for eg., that extra software license from a Canadian firm for eg.,). However, the rising exchange rate over a two-three year period can and will distort the capital formation of the Canadian economy. New investments will divert itself from existing manufacturing base and move towards the paraphernalia required for the oil industry. It is of course critical to distinguish between the dying industries of Canada and the ones forced to close out due to the rising exchange rate. Perhaps, it might be possible to wean that information from the manufacturing data etc.,

My own sense is that that is seems the loonie has found a new home in the 1.05-1.10 USD range. But, this is only a resting point. Over the next six months -- as oil prices continue their climb upwards and US housing numbers deteriorate along with growth -- one should be surprised if the loonie kisses 1.15-1.20 USD.

If I were a Canadian firm earning USD six months, I would be buying some CAD forwards...

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