By Sean Hyman You may have heard us call the Canadian dollar “the loonie” here in FX University on occasion. That’s because our neighbors to the north nicknamed their currency after the Canadian Loon depicted on their dollars and coins.

Frankly, the name fits – and not just because of the bird. The currency itself acts kind of “looney.” In fact, I think of it as bipolar.

You see there are two major “pulls” on the Canadian economy. First of all, Canada is a huge commodity-exporting nation, so major commodity prices including oil can influence their currency one way or other.

But on the other hand, Canada is also influenced by their biggest trading partner: us, the United States. So the second “pull” on their currency is based on how the U.S. is doing at any given time.

As a Forex investor, the tough thing to figure out is whether the Canadian dollar will trade based on commodity prices or what’s happening in the U.S.

As you know, the U.S. led the world into the latest recession. This was a horror story for Canada. After all, when the U.S. slows down, Americans don’t need as many goods or nearly as many commodities – including the oil, petroleum products and timber from Canada.

You can see this easily on the visual below.

As Goes the U.S., Eventually Goes Canada!

You can see by the GDP chart above, as the U.S. went into negative GDP growth (-2.5%), that Canada ended up in the same boat (-2.13%).

However, on the other hand, the loonie can also do well when commodities do well. So how does one figure out this currency?!? Actually, it’s easy to see which has a bigger pull on the economy at any given time.

Let’s go to the chart for details…

Invest in the Loonie when Both U.S. Stocks & Commodities Head Higher!

If you’re trying to figure out what the loonie will do next, you have to look at both the U.S.’s situation and commodity prices. And right now, I’d say whatever is happening in the U.S. has more pull on the loonie’s overall strength.

Why do I say that? Well take a look at the chart above. As you can see, in 2006 and most of 2007, commodities (like oil) and U.S. stocks (like the S&P 500) were going up…and the Canadian dollar (on this chart, the Canadian dollar fund, NYSE: FXC) ate this up.

Note: As FXC goes up, you would want to be short the USD/CAD pair in the Forex market to have the equivalent direction.

However, towards the end of 2007, of course U.S. stocks peaked and then fell off the map. You can see this in the top of the chart above. However, in the very bottom of the chart , you see that oil continued to rally for another 6 -9 months, yet the loonie still dropped off anyway. In other words, high-priced oil was NOT enough to help the Canadian dollar when the U.S. was suffering.

That’s why I say, when U.S. stocks are doing well (and especially when both U.S. stocks AND commodities are doing well), it’s time buy the loonie.

But, even if commodities continue to head higher, you still need to look at what’s happening in the United States to gauge the loonie’s strength. If U.S. stocks start to slump and the U.S. economy starts to slow down, it’s time to bail out of the Canadian dollar trade.

The Ultimate “Recovery” Play of the Year

By the way, if the central bankers have it right…and we’re past the worst and “green shoots” are starting to pop up once again, then it’s time to buy the loonie once again. And this is exactly why investors have poured back into it. Because BOTH stocks and commodities have stabilized recently. Also, Canadian exports have picked up lately.

Of course, it could go the other way too. If that happens, I suggest you bail out of this trade. Watch both U.S. stocks and oil for the signal. If they pullback, take your profits and run for a not so “bipolar currency.”

Bottom line: As long as stocks and commodities continue to perform well, then shorting the USD/CAD pair should do just fine. If, for some reason, U.S. stocks lose their momentum and start to head south again, then it would be time to bail out of your USD/CAD short position.

Happy Trading!

Sean Hyman aka Professor FX

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