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Things look great in Canada

Things are looking much better in Canada than in the U.S., and it shows. Once again the Canadian dollar has reached its highest level ever against the U.S. dollar, both on a nominal and inflation-adjusted basis. This chart compares the Can$ exchange rate vs. the U.S. with my estimation of Purchasing Power Parity, which is the exchange rate at which prices would be roughly equivalent in both countries. The loonie is strong, with the result that Canadians' purchasing power when traveling in the U.S. has never been greater (i.e., the positive gap between the actual exchange rate and PPP has never been larger).

Canada has just voted decisively in favor of a conservative government that will continue to pursue a pro-growth fiscal policy consisting of tax cuts and curbs on government spending. Canada's stock market is outperforming ours, its housing market has largely avoided the collapse we have suffered, its banks are doing well, its natural-resource-based economy is flourishing, taxes are being cut, and its budget deficit as a percent of GDP is less than half of what ours is (34% vs. 78%). What's not to like?

Going long the loonie is a tough decision, however, since it is pushing the limits of its valuation vis a vis the dollar. The news is great, but lots of good news is priced in. This leaves the loonie vulnerable to even the hint of commodity price weakness, and those fears are already stirring as gold and silver suffer from a bout of selling panic. Caveat emptor.

Full disclosure: I have no direct exposure to Canada or its currency at the time of this writing.

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