Parity for the Loonie could be here to stay
February 6, 2013
A large proportion of Canadian wood products exports go to the U.S. and the remaining are traded in U.S. dollars. As such, the forest sector is highly sensitive to the Canadian/US dollar exchange rate. The Canadian dollar has appreciated by about 56% since December 2002 and Canadian exporters may wonder whether it will keep climbing.
The remarkable correlation between oil prices and the appreciation of the Canadian dollar since 2002 (graph below) has led some analysts to characterize the Loonie as a ‘petro-currency’. If that were the case, the long-term projections of world oil prices [1 Mb PDF] would imply exchange rates well above parity for a long time (see graph).
Exchange rate (US$/C$) as a function of crude oil prices (in 2008 dollars)
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However, even on this simplistic graph one can see that a straightforward relationship between oil prices and the CAD/USD exchange rate does not tell the whole story. At low oil prices the CAD increases with increasing oil prices, but then after about US$80/barrel, the relationship breaks down, and the CAD hovers around parity.
A roundup of analysts from banks (e.g. TD Economics [706 kb PDF]), think tanks (e.g. MacDonald Laurier [73.4 kb PDF]), academics (e.g. Ivey Business Journal) and the Bank of Canada itself offers insight: the Canadian dollar has strengthened, in part because the Canadian dollar has been riding on high commodity prices (read energy), but in large part because the U.S. dollar has been so weak. More recently, capital inflows from foreign investors who see Canada as a safe haven have greatly contributed to the Canadian dollar appreciation despite lower commodity prices. The Canadian dollar does not appear to be a petro Loonie after all.
The combined outlook of key analysts forecasts that the Loonie could start depreciating, but likely not before 2015. In the meantime, it is expected to hover around parity. This means some continued challenges on the revenues front as Canadian wood products producers receive significantly reduced prices in Canadian dollar terms. However, on the flip side, a stronger dollar generally presents better opportunities for capital investment or foreign acquisitions, so companies may be able to benefit from these to offset some of the pricing challenges.