To understand what is happening to the Canadian dollar and the opportunities ahead, let’s do some economic time travelling, starting in 2000.
Back then, both the U.S. and Canadian economies were doing well, growing at 4% over the prior five years. However, the oil price had dropped to a cyclical low below US$20 and, as a result, the Canadian dollar depreciated to under US$0.70.
This was a turning point. The Canadian dollar started its long, slow ascent over 10 years, all the way to parity with the U.S. dollar, on the strength of a decade-long commodities boom. As the loonie appreciated, the consequence was it got harder and harder for most exporters to compete.
All that changed when the resource boom ended following the Great Recession. Emerging markets started to slow, and oil fracking enabled increased oil production. This demand-supply imbalance triggered a collapse in oil prices starting in the fall of 2014, from around US$100 to US$30 a barrel. Since that time, the loonie has depreciated by 30%.
What’s interesting, overlooking short-term volatility, is that the Canadian dollar tends to move in long-term cycles, driven by the relative strength of the Canadian economy.
Over the last 30 years, the Canadian dollar had before this month fallen below US$0.70 only once, from 1998 to 2002.
The other driver of currencies is relative interest rates, as investors are able to move money internationally to take advantage of arbitrage opportunities, using currency-hedging strategies to eliminate risk.
In his recent January speech, Bank of Canada governor Stephen Poloz referred to the divergence of interest rates as the “dominant theme across the global economy.” He was talking about the U.S. Federal Reserve starting its interest rate tightening cycle, while the European Central Bank, Canada and many other countries are decreasing interest rates. This is driving the U.S. dollar higher across a wide range of currencies.
The two contemporaneous effects – low commodity prices and divergence of interest rates – will continue to place pressure on the Canadian dollar.
Oil is now below the average cost of production for most of global supply, and in time prices will correct. However, the process is likely to take some time, and fracking capacity will continue to restrain an oil price recovery.
All this creates a once-in-a-generation opportunity for Canadian exporters to take advantage of a competitive currency. The economic stars align for exporters as the U.S. economy is growing, adding 2.5 million jobs last year.
Surprisingly, not a lot of small and medium-sized enterprises export.
According to Statistics Canada, exporters make up only 10% of small businesses (companies with fewer than 100 employees) and 34% of medium-sized businesses (companies with between 100 and 499 employees).
The data points to superior financial performance by exporters compared with non-exporters. Specifically, exporters generated higher sales, pre-tax profit margins and returns on assets, on average, compared with non-exporters.
If you already export, one strategy might be to allocate the extra profit you will earn in 2016 to increase sales and marketing spending internationally, diversifying the investment into other U.S. regions or into other countries. If you don’t export now, it’s an opportune time to explore how and where you could enter the U.S. market, build a business plan and find partners that can help you.
Business owners could also deepen their export growth by acquiring a Canadian company with large amounts of U.S. dollar revenue.
At this early stage of the currency cycle, the purchase price may reflect earnings made with a higher Canadian dollar from the last 12 to 24 months. The earnings potential might be greater in the future if the company can expand its market by leveraging this competitive advantage.
With all the economic uncertainty around, it’s easy to be driven by fear.
However, while the Canadian currency is undervalued, take advantage of the competitiveness it offers, and seize the opportunity while it lasts to expand your business in the biggest economy in the world. •
Robert Napoli ([email protected]) is vice-president of First West Capital, a division of First West Credit Union that finances acquisitions, buyouts and growth. He is also past president of ACG British Columbia, an association for deal-making and corporate finance professionals.
