Has the Canadian dollar finished rising?
Maybe, but this advisor cautions against making assumptions in this volatile market. He wants his clients to stay protected.
How difficult an environment is it for hog production in Canada? For Kevin Simpson, a recent meeting with one of Ontario’s top producers highlighted just how tough things have been.
“This is a very astute producer,” says Simpson, an Investment Advisor with RBC Dominion Securities in Waterloo, Ont.
“During the hog market crash of 1998, this client used the futures market aggressively and profitably to offset losses in the cash market, at a time when most producers were fearful of making any move to improve their situation.”
Simpson’s client noted that, as punishing as 1998 was for hog producers, 2007 was even worse. Why? Declining hog market prices. High feed costs. But most of all, the rapid appreciation of the Canadian dollar relative to its U.S. counterpart. At the beginning of 2007, it took $1.16 Cdn to buy a U.S. dollar. By September, the two currencies were at par. Fast-forward to early November and a U.S. dollar equated to just $0.94 Cdn. Since then, the two currencies have bounced back and forth, but the Canadian dollar remains strong.
“For hog producers, the appreciation of the Canadian dollar has made a difficult market situation that much tougher,” says Simpson, who furnishes this example to illustrate the point.
In October 2006, lean hogs were selling for $64.95 US per cwt. and $124.42 per ckg., index 100 in Ontario. By mid-October 2007, the lean hog price had dropped to $54.45 US, and those same Ontario hogs were trading at $92.41. In U.S. dollar terms, the hog price declined 16 per cent over 12 months, plenty bad enough. In terms of Canadian dollars, however, the price of hogs dropped by 26 per cent.
Crop prices were sharply higher in 2007, with all-time highs for wheat. A strong Canadian currency, however, reduces the gain for cash croppers. In early October 2006, cash soybeans were selling for $5.07 US per bu., then about $5.40 Cdn. By the same day in October 2007, nearest month soybeans had jumped to $8.77 US, but because of the newly upside-down exchange rate, this returned just $8.50 Cdn. The U.S. dollar price for soybeans went up 73 per cent during that year, but only 57 per cent in Canadian dollar terms.
Royal Bank of Canada sees Canadian dollar below par in ’08
According to a forecast released in early November, Royal Bank of Canada’s Economics team believes the Canadian dollar will weaken against its U.S. cousin in 2008. Royal Bank of Canada is forecasting that the Canadian dollar will end 2008 at $0.93 US. That’s a 20 per cent decline from the early November level of $1.07. For hog producers, and others affected by the currency relationship, this would be welcome news. For his part, Kevin Simpson is advising clients to continue hedging.
“For all my clients, I’m hoping for a lower dollar,” he says, “but I still want them to be protected against the ravages inflicted by rapidly rising currency.”
When advising agricultural clients on currency hedging, Simpson recommends three possible strategies. First, buy a Canadian dollar futures contract. Second, buy call options, which can be considered a form of insurance. Third, sell short puts. In each case, depending on how the hedge is set up, you can profit if the Canadian dollar rises. This gain would offset currency-related losses in a farming operation.
That’s the strategy, but during the dollar’s rise over the past few years, Simpson found many clients progressively less inclined to hear the message.
“Many farmers are value investors – having learned to buy low and sell high,” he says. “They were reluctant to buy Canadian dollars for $0.95 US, when they could’ve bought the Canadian dollar for $0.75 US a year or two ago. Hedging, however, pays off in times when prices hit lows or highs not seen in decades. Our short hedges made money in the hog crash of ’98, and Canadian dollar hedges are paying off in the bull market of ’07. This hedge still makes a lot of sense.”
Based on currency values over the past 30 years, it might still feel strange to see the two North American dollars trading at par. There might be a tendency to believe that par with the U.S. is a sort of ceiling price for the Canadian dollar. Simpson cautions that just because the Canadian dollar has climbed a long way, doesn’t mean it’s done.
When it comes to the exchange rate, he’ll continue to advise his clients to hope for the best and plan for the worst.
“Looking back over the last few years, every major move in the Canadian dollar has taken the market by surprise,” says Simpson. “Will it go higher? It’s impossible to know. But when your revenue comes through U.S. dollars, and your costs are in Canadian dollars, it’s important to manage that risk.”