The select membership of the AAA rating club is shrinking rapidly. You will soon have enough fingers to count all the AAA rated countries around the world. Since the recent Standard & Poor’s downgrade only 12 countries remain in this exclusive block: Australia, Canada, Denmark, Finland, Germany, Luxembourg, Netherlands, Norway, Singapore, Sweden, Switzerland and the United Kingdom.
When we consider that Germany and the Netherlands will have to recapitalise their banks sooner rather than later and that the economic situation in the UK doesn’t seem to be getting better, I expect this élite group to shrink even further in the coming months. We will soon be left with a group of Scandinavian socialist countries, where individual taxation is extreme, Switzerland and Luxembourg, physical refuges of the wealthy, Singapore which is really a transit port for Chinese goods and the commodity producers that are Canada and Australia.
If I had to choose between which country presents the best risk/reward as an investment going forward, my vote would definitively go towards Canada. I am biased, being Canadian myself, however I should also state that I haven’t lived there for years, avoiding the cold weather and prohibitive taxation levels. This doesn’t stop me from seeing the appeal of Canada as an investment. When Dr. Doom, Nouriel Roubini, described Canada as “a country with a relatively sound financial system, solid government balance sheet and a commodity sector that can withstand possible global economic risks” (Source: Huffington Post) he was onto something. Canada will soon emerge as a safe haven for foreign investors and should play an important role in everyone’s portfolio, on both the Fixed Income and on the Equity side.
Six reasons to invest in Canada
Commodities: As you may be aware, for every death two people are born on Earth today. Demand for commodities will continue to rise for the next 20 to 30 years. Of course, we will see setbacks – caused by either a rise of the US dollar or a slow down in China’s demand. As commodity demand increases Canada is positioned to profit from it. Canada has the second largest landmass in the world behind Russia. In recent years Canada has been the world’s largest producer of zinc and potash; the second-largest producer of nickel, asbestos and cadmium; the third-largest producer of platinum and titanium; the fourth-largest producer of aluminium and the fifth-largest producer of gold, copper, lead and cobalt (Source: Canadian Trade Commissioner). Canada is also one of the world’s largest suppliers of agricultural products, being one important producer of wheat, canola and other grains. With nearly half of Canada’s entire land surface covered by trees, Canada is the third largest exporter of forest products. And I can go on and on…
Energy: Canada is one of the only developed nations that are net exporters of energy. According to the Canadian government website, Canada has the second largest proven reserve of oil in the world. Canada is also the seventh largest producer of electricity and the world’s largest producer of Uranium. Remember that Canada has a population of less then 35 million; therefore most of the energy is destined to be exported, continuing to improve the trade balance going forward.
Composition of the index: Be aware that an investment in a Canadian fund or a Canadian ETF may bring more volatility to your portfolio. The Canadian economy presents less diversification then the US economy. When we compare the MSCI Canada Index to the SP500, Canada has twice the weighting in financials, twice the weighting in energy and six times the weight in materials. However also remember that the Canadian banks, the largest component of the index, are in much better shape then their US counterparts. If you are of the view that the North American economy is muddling through then the sector mix of the Canadian index should outperform the US market.
Total debt to GDP: In 1992 Canada lost its AAA rating based on debt denominated in foreign currencies, this followed years of uncontrolled spending by the Liberal party. During that period we watched the Canadian dollar collapse. I remember when the Bank of Canada had to increase interest rates by 2 per cent overnight to defend its currency, sending money market fund net asset value into negative territory. Ottawa recovered the AAA rating 10 years later, after reducing government spending, by a massive 8 per cent of gross domestic product, through a series of stringent spending cuts. Nothing was spared, not even education or healthcare. Today Canada is gradually reducing debt and now presents the lowest total debt to GDP ratio of the 10 largest developed economies. (Source: McKinsey&Company)
Currency: As we reach (or have passed) peak oil and demand for other commodities continues to rise, the trade balance of Canada will continue to strengthen sending its currency higher. This is already happening. To the surprise of all, Canada generated a trade surplus in November last year. It is just a question of time before the loonie trades 10 or 15 per cent higher then the greenback.
Political stability: The biggest risk to the Canadian economy was, for a long time, the threat of separation from the Province of Quebec. The relative prosperity experienced by the country, change in mentality and important influx of immigrants into the province are all reasons to be positive. The cessation talk is fading away and the annihilation of the sovereign party, Le Bloc Québécois, during the last Federal election clearly illustrates this. In a recent poll, 63 per cent of Quebecers said that they see no contradiction in being both proud Québécois and proud Canadians at the same time.
The trade: Many trades are possible here, the simple ones available on a US exchange are: buy the index through the iShares MSCI Canada Index Fund [s:EWC], the currency through CurrencyShares Canadian Dollar Trust [s:FXC] and for the more adventurous investors, I recommend the Guggenheim Canadian Energy Income ETF [s:ENY] an interesting play on the oil sands, especially with the situation developing in Iran. I have strong convictions that, long term, the Canadian economy will continue to outperform other developed market economies without providing as much volatility as emerging markets. If you have been reading my column from the start, you know that I am optimistic , however in the case of a collapse of Europe (30 per cent probability), the Canadian dollar will drop like a stone, as will the price of oil, other commodities and financial sector stocks.
Disclaimer: Clover is currently long EWC and long ENY in some of its client’s accounts. Clover has no positions in FXC. Clover has not made any transactions in any security mentioned in the past 72 hours and will not make any purchases or sales in the 72 hours following publication of this article. Eric can be reached at [email protected]