Is Canada’s Resource-Oriented Economy a Good Bet?

Earlier this week we looked at America’s southern neighbor, but how about the one to the north? Canada is well known for having copious quantities of natural resources such as oil, gas, gold and other precious metals, a wide variety of base metals, and fresh water.

But Canada is also America’s largest trading partner, which means its economic fate is inextricably linked with ours. Can Canada’s stocks outperform their American counterparts during downturns?

A good bellwether is the S&P/TSX 60 Index, a compilation of the 60 largest companies on the Toronto Stock Exchange as measured by market capitalization across ten industry sectors. Interestingly enough, this index trades on both sides of the border as an ETF with a different symbol. On the Canadian side, you can trade the iShares S&P/TSX 60 Index Fund as XIU.

Here you can see that XIU has tracked the DJIA quite closely until February, when it began to dramatically outperform. Right now support at the 100 week moving average is holding firm, but there is also historical resistance at current levels and the fund could break either way from here. However, our bias would be bullish as XIU has held firm over that 100 week average for some time.

The same index also available on the Amex under the ticker symbol EWC as shown below.

Here we see that EWC has more or less tracked the DJIA but not as closely as XIU. Then it began to outperform the Dow as early as September 2007. However, its net gain against the Dow is now virtually the same as XIU.

But how can the same ETF behave so differently on two different exchanges in comparison to the Dow?

Currency Movements as Leading Indicators

One answer is the currency difference, as XIU trades in Canadian dollars in Canada and EWC trades in U.S. dollars in America. Here’s a two year chart of the U.S. dollar against the Canadian dollar to give you a rough idea of their recent history:

As you can see, the U.S. dollar dropped steeply in September 2007 and this is reflected in EWC’s superior performance since that time.

But strangely enough, there was no such performance bonus during the earlier drop which started in April 2007. It would appear that the market didn’t begin losing faith in the U.S. dollar and the Dow until September (when the two dollars reached parity with one another). This moment of parity was in fact a fairly important historical level for psychological reasons as it hadn’t happened since the mid 1970’s when the inflation scare was in full swing.

But strangely enough, investors in the Canadian dollar denominated XIU did not get the benefit of this event until February 2008, even though the USD/CAD performance has been fairly neutral since that time. (If anything, it’s been slightly favorable to the U.S. dollar!)

The best lesson we can take from this chart comparison is that currency movements can act as leading indicators for securities trading in two differently denominated markets. You won’t get an instant payback from a currency move, but a currency trend will eventually pay profitably in terms of future stock and fund performance. After all, the fund has outperformed the Dow regardless of currency denomination for some time now.

Turning Points in Canadian Shares

Let’s focus on EWC now. Mining, banking, oil & gas, fertilizer and insurance are all covered in EWC, making it a comprehensive proxy bet on the entire Canadian economy.

Right now EWC is sitting at important support near $29, although it failed to hold at its 50 week moving average.

A strong hammer candle (a good example can be seen in April 2007) would be advisable before buying in, but EWC is already looking tempting as a buy due to the behavior of the Money Flow Index.

Money Flow – The Importance of Volume

Shown as MFI on the chart above, the Money Flow Index is used to determine the strength of a current trend by analyzing the price and volume together. MFI is calculated by using the following formula:

Typical Price = (High + Low + Close) / 3
Money Flow = Typical Price x Volume
Money Ratio = Positive Money Flow / Negative Money Flow
Money Flow Index = 100 – (100 / (1 + Money Ratio))

Overall, MFI is similar to the Relative Strength Index (RSI) with the key fundamental difference being that MFI also accounts for volume.

And as with other oscillator-type indicators, here are the primary ways MFI can help you predict turning points:

1) The oscillator moves into a sell zone or a buy zone, represented on this chart at the 80 and 20 levels, respectively. Right now the MFI for EWC is right in the buy zone which produced excellent results the last time this occurred in January.

2) The oscillator does not confirm a new price high or low. There are several examples including June 2007 (the price rose even as MFI dropped out of the sell zone) … October/November 2007 (MFI failed to even reach the sell zone and showed two lower peaks in succession as price rose yet again) … and May/June 2008 (new highs with a lower MFI peak in June).

Right now the combination of good support at $29 and MFI resting in its buy zone would count very heavily in favor of a bullish stance on EWC. The safest purchase would be the one made just after MFI has left the buy zone in case it spends an extended interval churning in that price area.

Blackberry Mania – Time To Buy In?

One of the reasons that EWC has done so well lately is Research In Motion Limited (NASDAQ – RIMM), a Canadian wireless device company best known as the developer of the BlackBerry handheld communication device. RIMM generates US$6 billion in revenue each year and employs more than 8,000 staff to create, program, market and sell BlackBerrys, Inter@ctive pagers, and various embedded wireless data components.

A top performer, RIMM has held quite firmly over its 50 week moving average and has been so strong that its 200 week moving average is barely showing on the chart. However, it’s now getting squeezed between historic resistance at $130-$140 and that 50 week average which now sits at $115. It will break one way or the other before much longer.

But at the moment it is impossible to say exactly which direction RIMM will go. MFI is neutral and is not giving us any hints on buy/sell zones or divergences between MFI and price.

Therefore, our suggestion is to wait until a break occurs. If you’re not that patient, then at the very least wait for a strong hammer to indicate a bottom or a shooting star to indicate a top. A good example of the former can be seen in the second week of July and two good examples of the latter can be found in the last half of October 2007.

So ‘wait and see’ is advised for this high flyer. Right now EWC (or XIU on the Toronto Exchange) is a safer bet.

Good investing,

Damon Wright
Analyst, Oxbury Research