The Canadian dollar has been outperforming the U.S. dollar for a variety of reasons, and overall it’s hard not to be bullish the CAD. However, there are technical signs it hit a near-term top in mid-October that could hold for a while. This should offer shorter-term traders some selling opportunities, and longer-term bulls an opportunity to get in at cheaper levels.

Why the Canadian Dollar is Strong

Rich in natural resources, Canada has strong fundamental prospects due to world demand for its oil, base and precious metals, and agricultural products. Canada has what the world wants. Canada produces tangible commodities that are in high demand.

In addition, the Canadian economy and its banking system have held up better than many others in the depths of the global financial crisis over the past two years. Canada has managed fiscal and monetary policy better than its G7 peers, and that has attracted foreign capital. Canada’s banks are in a stronger position as competitors falter.

Canada’s politically stable government is also friendly toward foreign investment; corporate tax rates are coming down to accommodate it. There have been takeovers of Canadian natural resource companies and investments in the oil industry that are bringing in capital.

However, the Bank of Canada doesn’t enjoy this currency strength, as it creates some policy issues. A strong currency puts pressure on Canadian economic performance, and the BOC has suggested it is likely to try to fight it. In testimony to the House of Commons on October 27, Bank of Canada Governor Mark Carney stated that the rise in the CAD will slow economic growth, and said options to check the currency include quantitative easing.

Monthly Chart – CAD

Vallance_CD1_10-27-09.png

The CAD has moved up 15 percent this year, and has moved up 24 percent from than the March 2009 low. I believe the market is a bit overbought. During this time, the economy was contracting, yet the currency moved higher as the U.S. dollar weakened. I think the U.S. dollar is likely to correct up for a while, and it might be hard for the CAD to fight that flow of capital. It’s possible the CAD got a little ahead of itself.

Daily Chart – CAD

Vallance_CD2_10-27-09.png

 

On the daily chart of the CAD, you can see circles on the left side representing lows, and one where it looks like a topping point was hit, on October 15. This chart shows how the market moved up in classic fashion, in a five-wave pattern. Once we hit five waves, the market typically tops and a correction starts.

The CAD broke out of a sideways channel above 94 cents to close at 94.36 on October 6, 2009. Quickly from there, CAD traded to a high of 97.98 and then reversed, to close down at 96.77 on October 15. This was an outside day key reversal and a signal the market could be running out of gas.

Trading down below 94 cents, takes the CAD back into the trading range between 91 and 94 cents, we don’t know whether that correction was enough or how far it might continue. You don’t know where the bottom is until it shows up, that is the benefit of hindsight.

Technical analysis is always subject to interpretation, and it’s possible that we’ve only begun a third wave down, and not the fifth. However, in my opinion, technically, the market could test 89.90 in the near-term as the sell-off from the October 15 peak continues.

One thing to keep in mind, it seems that everyone is generally bullish the CAD and bearish the U.S. dollar. When you get too many people leaning on one side, it will eventually tip. The question is whether there will be a mild, or sharp correction? And how long will it last? Look for confirmations of a bottom or top from other technical indicators. I like to watch the Moving Average Convergence-Divergence (MACD) for a signal.

If you are short-term trader and are bullish the dollar, you might want to consider getting long near 92.50, and put a stop about 1 cent below. If you are willing to risk more, you should risk the trade to a close below 91. If CAD does trade below my 89.90 technical target, the picture for the currency changes to a bearish scenario.  In the big picture though, I think the Canadian dollar’s prospects look good, the economy has a lot of fundamentals on its side.

Andrew Vallance is a Senior Market Strategist based in Toronto, and is serving clients in Canada. He can be reached at 416-369-7948 or via email at avallance@lind-waldock.com. You can follow Andrew on Twitter at www.twitter.com/LWAVallance.

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