I think the reasoning below also applies to Canadian energy stocks, and especially to the energy trusts that pay out large dividends in Canadian dollars:
Dr Richard Appel
Financial Insights
April 23, 2003
Few gold stock investors realize that many of their transactions originate in a foreign currency. Yet, their investment profit or losses may be greatly influenced by the change in parity between the U.S. Dollar and the currency of a foreign nation.
Whenever stocks have their primary market listing on a foreign stock exchange, investors are generally confronted with the payment for the shares in that nation's currency. This is due to the fact that the location where the transaction is consummated is the determining factor in the form of settlement. If you travel or dine in Paris you pay for your purchases in French francs. Similarly, if you trade a French security, settlement is made in the local French currency. This is similar throughout the world. It doesn't matter if the stock transaction is executed in China, Switzerland, Germany or New York.
Normally, if you are an American and have a broker who also resides in the U.S., any currency exchange is executed by the brokerage house with little or no knowledge to the client. The broker typically only discusses the price of the foreign security in dollars. Similarly, the price that is listed on the confirmation is also denoted in U.S. dollars. This is preferred by most Americans as few of us regularly deal in foreign currencies, as for example, do the Europeans. For this reason it is difficult for most Americans to think in dual currencies. Further, since most brokers likewise cannot adequately explain the currency component of the trade to their clients, they tend to avoid so doing. Thus, while many individuals who invest in Canadian resource companies believe that they are traded in U.S. dollars, they actually are bought and sold in the Canadian currency.
During the gold rally that began in early 1993, I invested in numerous gold exploration companies that traded on the Canadian stock exchanges, primarily in Vancouver. The Canadian Dollar was worth approximately $0.80 U.S. at the inception of gold's price rise from its $323 nadir. When gold peaked at $420 in 1996, the Canadian Dollar had declined to about $0.73 U.S. Investors like myself who had early invested in gold's advance, while they may have benefitted from the price increases in the Canadian junior companies, experienced their profits reduced when they sold their stock. This resulted when the received Canadian currency was converted back into U.S. dollars. It represented a currency loss of 9% or more, if they had bought their shares when the Canadian Dollar was worth about $0.80 U.S. and sold them when the Canadian Dollar had weakened to $0.73 U.S. The Canadian Dollar was destined to decline further until its Bear Market ended at about $0.62 U.S. at the beginning of 2002.
In my youth, I remember the Canadian Dollar being worth above parity with its U.S. counterpart. I did not regularly follow the fluctuations of the two currencies, but I recall the Canadian Dollar being worth above $1.10 U.S. at one point. This was a period when their government exercised sound monetary policy and prior to the assumption of power by its present socialist leaning regime.
Through the years the Canadian currency has fluctuated greatly against our own dollar. During the past two decades it has traded between a high of about $0.90 U.S. and its recent low that was posted at $0.62 U.S. This has acted to either the benefit or the misfortune of Americans executing stock transactions in Canadian dollars, and was dependent upon the time-frame in which they operated. If one bought Canadian securities when that dollar was worth little, when compared to the U.S. unit, and sold when the Canadian dollar had risen in value against the U.S. dollar, they would reap a substantial reward. Conversely, if they acquired Canadian investments when the Canadian Dollar was high when compared to the U.S. dollar, and sold their assets when the Canadian money had declined in value compared to it's U.S. equivalent, they would suffer.
I believe that a few examples will be helpful at this juncture to better understand how investors can either benefit or be hurt from a change in the U.S. and Canadian dollar's parity. For simplicity we will assume that there were no involved commissions or transaction costs.
If an American investor purchased $1,000 Cd. worth of a Canadian stock when the Canadian Dollar was worth $0.90 U.S. it would cost him $900 U.S. ($1000 Cd. x $0.90 U.S.). To make this easy let's suppose that he later sold the stock at the same price, but the Canadian Dollar had fallen against the U.S. dollar to $0.80 U.S. After the sale he would only receive $800 U.S. ($1,000 Cd. x $0.80 U.S.) and would suffer a $100 U.S. loss ($900 U.S. minus $800 U.S.) in the completed transaction. This, despite the fact that there was no change in the value of the securities. However, if the same $1,000 Cd. transaction occurred, but the Canadian Dollar originally was worth $0.80 U.S., giving him an investment cost of $800 U.S. ($1,000 Cd. x $0.80 U.S.), and later had appreciated to $0.90 U.S., for a value of $900 U.S. ($1,000 Cd. x $0.90 U.S.), the investor would instead be rewarded with a $100 U.S. currency profit ($800 U.S. cost plus $100 U.S. currency gain). Again, despite the fact that the underlying stock had remained unchanged.
It gets more interesting, especially with the likelihood that the Canadian Dollar is in a major Bull Market! The currency component profit or loss is magnified by the change in the asset's dollar value between the time of the purchase and its sale. Let's again assume that an investor begins with a $1,000 Cd. investment in mining stocks. Further, it increases to $5,000 Cd. and the Canadian Dollar appreciates in value from $0.80 U.S. to $0.90 U.S. In this case his original $800 U.S. investment rises not to $4,000 U.S. ($5,000 Cd. x $0.80 U.S.) but to $4,500 U.S. ($5,000 Cd. x $0.90 U.S.) This represents an additional $500 U.S. profit due solely to the Canadian Dollar's increase against the U.S. dollar. Compared with the original $800 U.S. cost it produced an incredible result in that his original investment showed a 62.5% increase ($500 U.S. additional profit compared to the $800 U.S. original cost) which was solely due to the rise in the Canadian Dollar. Of course if the Canadian unit declined from $0.90 U.S. to $0.80 U.S. during the period his initial investment would have been $900 U.S. ($1,000 Cd. x $0.90 U.S.) and his sale price would only be $4,000 U.S. ($5,000 Cd. x $0.80 U.S.) causing a reduction in his final profit after the currency component was factored in.
I recognize that this may be confusing, but it gets easier from here. As you can see, the change in parity between the Canadian and U.S. dollars can be of considerable importance to the American investor in Canadian mining equities. In the earlier 1993-1996 experience the decline in the Canadian Dollar from $0.80 U.S. to $0.73 U.S. represented an currency loss to investors. This was due to the Bear Market that existed in the Canadian Dollar during that period. However, during our current Bull Market in Canadian mining stocks I believe that we are destined to experience a highly profitable coincident Bull Market in the Canadian Dollar.
The Canadian Dollar bottomed at $0.62 U.S. in the first weeks of 2002. It has since risen to its present U.S. dollar parity of about $0.69 U.S. This has already bestowed a significant exchange rate profit to U.S. investors who early devoted capital to the Canadian mining market.
The Canadian Dollar has already been a stellar performer during its U.S. counterpart's incipient Bear Market. I believe that it has entered a Bull Market against the U.S. Dollar! Further, for me, when the Canadian currency rises above $0.70 U.S. it will confirm $0.62 U.S. as having been its absolute Bear Market low point. In this event, I anticipate that the Canadian unit will quickly rise to test $0.75 U.S. Additionally, given the enormous forces that I believe are destined to further weaken the U.S. Dollar, when $0.75 U.S. is surpassed it is likely that the Canadian Dollar will rise to threaten its next area of important resistance which is the $0.88 U.S. level.
If I am correct, not only will American investors greatly benefit from the unfolding Bull Market in Canadian junior exploration companies, but they will simultaneously enormously gain from the appreciation that I foresee for the Canadian Dollar. This will truly be a windfall profit which can add an additional 20% or more to the higher portfolio value, that I believe the Bull Market in Canadian mining stocks is destined to bestow upon its investors.
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