July 12, 2007
Canada: Similar to Investing in the US but without exposure to its weaknesses
The Marker, July 12, 2007, p. 54, by Iddo Sagi, Ran Israeli and Yotam Ironi
Altshuler-Shacham believes that the Canadian economy has many advantages over the American which derive from a superior macro environment and from wealth of natural resources.
Canada is one of the richest countries in the world in terms of its natural resources and its GDP is getting closer to that of the US. Canada benefits from reserves of oil and natural gas as well as from growth and a surplus in its current account.
Canada shares many similarities with the US, however, there are still major differences in their markets' macro conditions. For example, the population in the US is nearly 300 million whereas in Canada it's 32 million in spite of its vast territory . The US has an import surplus which undermines the stability of the American dollar whereas Canada has an export surplus. The US has a large government deficit whereas Canada has a budget surplus.
The macro conditions led to the evaluation of the Canadian dollar compared to the US dollar. In January 2003, one US dollar was worth 1.55 Canadian dollars. In June 2007, it became 1.07 Canadian dollars . An evaluation of 30 percent over a period of four and a half years.
What led to this situation? The first factor is the weakness of the US dollar. The US trade deficit was 840 billion dollars in 2006. The second factor is the Canadian export surplus of 50 billion dollars in 2006. The evaluation of the currency has only slightly reduced the Canadian export deficit. One of the reasons for this is the substantial price increase in oil and metals which are part Canada's exports. Canada is one of few western countries to export more oil and natural gas than it imports. In addition, in 2006 , the GDP in Canada reached thirty-five thousand dollars which is still 20 percent lower than the GDP in the US .
Canada's economy is less than a tenth of the US economy and it is highly dependent on the US economy. Eighty-five percent of Canadian exports are destined for the US and about fifty-nine percent of its imports come from the US. A cooling of the US economy would directly impact the Canadian economy. However, there are limitations to this correlation. A substantial part of Canadian exports to the US consist of products such as oil, natural gas and metals for which demand is relatively stable. The export of those products would be less affected by a cooling of the US economy. Another weak point is the extent of the evaluation's effect on the export and on companies' profitability. Although the trend of gradual evaluation has been going on for several years, it has only had a limited impact.
The Canadian economy has several advantages over the US economy including its trade balance and the quantity of minerals relative to its population. In addition, the policy of promoting immigration of those with a higher education improves its human assets and covers for the braindrain to the US.
Oil reserves rate second in the world
One of the leading industries in the Canadian economy is the the energy industry. Canada has many natural resources, mainly oil, natural gas and metals. Canada's oil reserves are rated second in the world, located mainly in Alberta. A large part of the oil is found in the Tar sands which is a mix of sand, mud and Bitumen. The digging and the distillation of the sand is an expensive process, 28 dollars per a barrel, which makes the process unprofitable when the price of oil is less than 30 dollars a barrel. Today, the process is profitable and according to the OECD report, 3.5 million barrels a day will be produced in Canada in 2015 from these oil sands.
The western part of Canada is rich in minerals but it is less populated and suffers from lack of manpower. In addition, export of goods strengthens the Canadian dollar and makes it difficult for the Canadian market to compete with the US.
The banks are multi-national corporations
Banking has a tremendous impact on the Canadian economy. The economic growth over the last few years and financial stability have improved the state of the financial institutions in Canada. There are five big banks operating in Canada and the strategy of most of them includes expanding their services into insurance and other financial domains as well as expanding in the arena of international banking. Most of the banks have set up branches in numerous countries, mainly in the US, as part of the process of becoming multinational corporations.
The overall weight of those banks in the leading Canadian stock index, S&P;/TSX60 is 23 percent. Therefore a direct investment in this index creates a wide exposure to the banking sector on top of the exposure to the energy sector. When an investment consultant is weighing investments in North America, he should consider the possibility of including Canadian companies. The economic environment of both markets are very similar but the Canadian market has an advantage in the macro environment and in large surplus of natural resources.
The biggest banks in Canada
1. Royal Bank of Canada (RY)
2. The Bank of Nova Scotia (BNS)
3. Toronto-Dominion Bank (TD)
4. Bank of Montreal (BMO)
5. Canadian Imperial Bank of Commerce (CM)
Leading companies in the energy sector
Suncor Energy (SU)- specializes in oil production from oil sands in Alberta
Encana Corp (ECA) - specializes in natural gas production, the main source of its income. Also deals in oil production and in extracting oil from the sands.
Canadian Natural Resources (CNQ)
Syncrudde Canadaq Ltd.- a private company.
The writers are analysts at the research department of Altshuler-Shacham.