Trade Idea – Foreign Exchange – Loonie set for near term tumble
Highlights
The tentative agreement reached by OPEC last Wednesday has sent oil prices to the top of their recent range and lent support to oil linked currencies.
In practice the production limit will be hard to implement and oil prices will likely retrace gains in coming months.
The CAD looks to continue its downtrend as extended positioning corrects lower and monetary conditions are eased.
OPEC surprises markets
Global crude benchmarks and oil linked currencies jumped last Wednesday on news that members of OPEC had tentatively agreed to implement a production target for the first time in seven years. Both commodity and currency markets responded positively to the surprise deal that was viewed broadly as an unlikely prospect due to long standing differences between key group members, Saudi Arabia and Iran. While the deal certainly marks a shift in stance of the oil exporting group, we do not believe it is enough to sustain support for the CAD which is at risk from a confluence of bearish factors, specifically underwhelming economic performance, stretched speculative positioning and technical resistance. We therefore see current levels as an attractive point to gain long exposure to the USD/CAD and EUR/CAD currency pairs which are set to benefit from near term oil weakness.
Symbolic but not practical
We believe the uplift in the oil market provided by the latest OPEC agreement will not last for long as the practicalities of the arrangement and wider concerns over slowing global oil demand growth keep oil prices contained. The deal itself, while an important move symbolically, did not provide a definite promise to remove a significant amount of output from the global oil market (removing anywhere from 200-700k barrels per day (bpd)) and requires the implementation of country level quotas. This is a large and politically sensitive task and is unlikely to be completed before the next OPEC meeting in November. In addition, the deal failed to provide clarity over conditions for countries under duress such as Venezuela, Nigeria and Libya where production is currently far below capacity, but has the potential to increase in the interim. Thus, support from oil prices is therefore likely to be absent for the CAD in the coming months.
(Click to enlarge)
CAD underperforms NOK
While both the NOK and CAD are heavily linked to the oil price, prospects for the two currencies have recently diverged. Latest growth and inflation data from Norway has surpassed the expectations of its central bank, causing the Norges bank’s
Executive Board to deliver a more hawkish policy message and raise its projected rate path. In contrast, lacklustre inflation, retail sales and manufacturing data has prompted a more dovish tone from the Bank of Canada (BoC), which makes it increasingly likely to ease monetary policy at its upcoming meetings. This has been reflected in the relative outperformance of the NOK in the past month, which has rallied by 2.8% relative to CAD on a trade weighted basis (see Figure 1).
Positioning stretched
The USD/CAD and EUR/CAD are on strong longer term upward trends (CAD weakening) which look well placed to continue. Net speculative positioning underpinning the CAD is hovering at record highs and looks increasingly subject to a correction. A fall in oil prices or further easing by the BoC could see CAD longs (which are at the strongest level in two years) fall sharply and shorts gather momentum, exacerbating any rise in USD/CAD and EUR/CAD.
Investors wishing to express the investment views outlined above may consider using the following ETF
Securities ETPs:
Currency ETPsEUR Base
ETFS Long CAD Short EUR (ECAD)
ETFS Short CAD Long EUR (CADE)
GBP Base
ETFS Long CAD Short GBP (GBCA)
ETFS Short CAD Long GBP (CAGB)
USD Base
ETFS Long CAD Short USD (LCAD)
ETFS Short CAD Long USD (SCAD)
3x
ETFS 3x Long CAD Short EUR (ECA3)
ETFS 3x Short CAD Long EUR (CAE3)
5x
ETFS 5x Long CAD Short EUR (ECA5)
ETFS 5x Short CAD Long EUR (CAE5)
Currency BasketsETFS Bullish USD vs Commodity Currency Basket Securities (SCOM)
ETFS Bearish USD vs Commodity Currency Basket Securities (LCOM)
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The CAD and NOK have risen 9.4%* on average against the US Dollar in 2016, closely tracking the recent unrelenting rise in oil prices from their trough in February (see Figure 1). The rally comes despite both the Bank of Canada (BoC) and the Norges Bank outlining concerns over the health of their respective domestic petroleum industries and the impact of weaker global environment on national exports. While in the longer term these issues could pose risks, in the very near term it is likely that oil prices will continue to display strength and boost the CAD and NOK further.
Figure 1: Crude rally lifts oil currencies
(click to enlarge)
Latest oil move justified
Unlike previous rallies which have been purely speculative, the latest leg up in oil prices appears more sustainable, having being driven, at least in part, by improving fundamentals. In its latest report, the International Energy Agency (IEA) suggests that its long held belief that the global oil market will balance by the third quarter of this year is starting to take shape. US oil supply cuts appear to be gathering momentum, global demand remains robust and further production increases from the OPEC oil cartel look increasingly unlikely (see Figure 2, ETFS Commodities Research: Oil rally has legs).
Downward trend looks strong
From a technical perspective the current downward trend in the USD/CAD and USD/NOK appears well established, with the 50 daily moving average (DMA) crossing below the 100 DMA last month* for both pairs, a typically bearish indicator. For the CAD the current trend has also been reaffirmed by net speculative positioning, which has turned positive for the first time in over three years as an increasing number of investors start to acquire long exposure.
Figure 2: Global oil market to balance
(click to enlarge)
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Volatility turnaround to drive asset class returns
ETF Securities FX Research – Volatility turnaround to drive asset class returns
NOK and GBP to outperform
Summary
Investor uncertainty remains elevated. However, investors differ with consumers, with consumer sentiment on an uptrend, lifted by jobs and low energy prices.
Currency volatility expected to moderate as investors convinced by underlying strength, helping support a ‘risk–on’ environment.
The British Pound has historically had a strong inverse correlation with volatility.
Currencies battered by volatility to turnaround, with Norwegian Krone and British Pound leading the way higher.
ETF Securities Research team
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• Oil prices continue to slide.
• European bourses generally traded higher although Greek stocks were heavily hit after the reopening of its market.
• Commodity currencies diverge.
Declining oil prices led the commodity sector lower, with a swelling glut in production weighing on price. We believe that the current low oil price environment will encourage high cost producers to cut back on production, paving the way for price gains in the future. An appreciating US dollar maintained pressure on the commodity complex more generally. With 215,000 jobs added to the US economy in July, the Federal Reserve is likely to remain on track for an interest rate hike later this year. Consensus expectations are for a September hike, although the futures market is looking further out in the year for the central bank to pull the trigger.
Commodities
Oil prices continue to slide. WTI and Brent crude oil benchmarks fell 8.0% and 7.1% respectively to the lowest levels since March and January. The global supply glut shows little sign of relenting. US oil rigs in operation have increased three weeks in a row. OPEC’s monthly report due tomorrow is likely to confirm that Saudi Arabia has continued to increase production beyond 10.5mn barrels per day, adding more oil to an oversupplied market in it pursuit for market share. As the summer driving season in the US starts to wind down and refineries undergo maintenance before the winter period, demand for crude is likely to hit a lull, weighing on price in the short-term. Current conditions are likely to drive the cuts in capex to high-cost non-US, non-OPEC production, helping to tighten supply in the future. Wood Mackenzie estimates US$200bn of capex cuts across the industry, primarily in deep-sea production.
Equities
European bourses generally traded higher although Greek stocks were heavily hit after the reopening of its market. The Greek Stock Exchange re-opened after a five-week hiatus, allowing investors to sell their holdings. Greek stocks fell an initial 23% on Monday, before trimming losses to just 16% by Friday. European manufacturing purchasing managers indices surprised to the upside, lifting investor sentiment about the pace of the economic recovery. The DAX, FTSE MIB and FTSE100 gained 2.7%, 1.8% and 1.3% respectively. MSCI China A-Shares ended the week 0.4% higher as the market responded to the equity market support offered by the government. An estimated US$144bn has been spent by the government on supporting the market and we believe a considerable amount of resources are available to the China Securities Finance Corp, the state-owned margin lending agency that is the main conduit for injecting rescue funds into the market.
Currencies
Commodity currencies diverge. The Australian dollar increased 1.0% against the US dollar after the Reserve Bank of Australian left rates on hold at 2%. Despite disappointing economic data amid weak resource prices, a buoyant property market is driving the RBA’s reluctance to cut rate too far, especially as the efficacy of further cuts is likely to decline as we reach the zero bound. Falling oil prices weighed on oil exporting countries, with the Norwegian Krone and the Canadian dollar dropping 1.4% and 1.0% respectively against the US dollar. We expect the CAD and NOK to outperform AUD and NZD in months ahead as the oil price begins to recover. The US dollar rallied against most currencies, with the latest labour market data giving fuel for the Federal Reserve to hit the trigger on rate increases later this year. The Bank of Japan remained dovish at its latest policy meeting, helping the Yen depreciate.
For more information contact:
ETF Securities Research team
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T +44 (0) 207 448 4336
E info@etfsecurities.com
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Investments may go up or down in value and you may lose some or all of the amount invested. Past performance is not necessarily a guide to future performance. You should consult an independent investment adviser prior to making any investment in order to determine its suitability to your circumstances.
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