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Short Selling Canadian Banks, Loonie A Bad Sign For Economy

Bets Against Canada's Economy Reach A Frenzy
Kiril Strax via Flickr

Global investors are turning against Canada’s economy, placing some of the largest bets on record that the country’s housing market, financial sector and currency are in for a rough ride.

A report Monday in The Financial Post indicates that a near-record amount of money is being placed against Canada’s major banks.

The length of time it would require investors shorting Canadian banks to cover their debts if the stock went up is now at 10.3 days, compared to just 1.3 days for U.S. banks. Any ratio above five suggests investors are pessimistic.

That follows a report last week that the Canadian dollar has become the second-most shorted major global currency, after the Japanese yen, suggesting investors widely expect the Canadian dollar to keep sliding.

Several trends appear to be behind the negative sentiment, including a weakening housing market and falling prices for commodities such as oil and gold. Both of these trends could impact the country’s economy, given Canada’s well-known reliance on commodities, and given that housing now supports a greater percentage of Canadian jobs than it has in recent history.

A hedge fund in California is going “all in” against Canada’s economy, The Globe and Mail reports. San Francisco-based Hyphen Partners LP is putting 95 per cent of its clients’ assets into bets against Canada’s housing market and banks.

“Canada faces two risks,” Hyphen Partners head Vijai Mohan told the Globe, referring to housing and banks. “Very few people are looking at those risks simultaneously. That collectively presents a lot of opportunity” for those who wish to make money off the Canadian’s economy’s expected decline.

So far, Canadian banks’ earnings have held up but recent data suggest there is a slowdown in the credit market, which in turn could have a negative effect on bank earnings.

House prices in Canada suffered six straight months of declines before leveling off in April, according to Teranet. But sales volumes have dropped sharply over the past year — down 15.3 per cent from a year earlier, according to the latest numbers — and the supply of homes available on the market is growing relative to the number of buyers -- a bad sign for future prices. (House prices in Canada remain 62 per cent above U.S. prices, on average.)

While many Canadian banks and real estate groups predict a soft landing for the housing market, the international community is less convinced, with Capital Markets predicting a 25-per-cent drop in house prices, and The Economist indicating Canada has one of the most overvalued housing markets in the world.

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The housing slowdown

Danger Zones For Canada's Economy 2013

Sliding commodity prices pose another risk to Canada’s economy. The price of gold suffered a mini-crash last week, even as Toronto-based Barrick Gold, the world’s largest gold producer, reported an 18-per-cent drop in profit. (A shareholders’ revolt followed, with investors rejecting the company’s executive pay plan.)

Canada’s S&P/TSX index has performed considerably worse this year than stock exchanges around the world, largely the result of the fact Canada’s stock markets are heavy on commodity companies. As of Monday afternoon, the U.S. key S&P 500 index was up 11.89 per cent on the year, and sitting in record-high territory. The Canadian S&P/TSX index was up a paltry 0.12 per cent for the same period.

Analysts at Citibank and elsewhere have declared “the end of the commodities super-cycle,” meaning they expect the long run of rising commodity prices over the past decade to end, to be followed by a long period of price declines.

If that were to happen, Canada’s economy could suffer from sluggish growth for years to come, dependent as it is on natural resources. Canada is the seventh-largest producer of gold in the world, and the sixth-largest producer of oil.

Regardless of whether one subscribes to the “commodities super-cycle” theory or not, evidence of hard times for Canada’s commodity companies is already appearing.

Imperial Oil, owner of the Esso brand, saw profit fall 21 per cent in its earnings report released last week. Cenovus, the fourth-largest oil producer in Canada, saw its profit fall by more than half in the first quarter of this year. And TransCanada, builder of the Keystone XL pipeline, saw higher profits but missed analysts’ estimates all the same.

With all this going on, “speculators have ganged up on the Canadian dollar by shorting the currency like there was no tomorrow,” National Bank Financial chief economist Stefane Marion told The Financial Post. “Falling commodity prices, disappointing economic data and a major downgrade by the Bank of Canada to its 2013 growth outlook have all contributed in altering perceptions about the loonie.”

But while the Canadian dollar is subject to the same ups and downs as all major currencies, the bets against Canada’s banks are harder to understand for some analysts.

Granted, the banks are exposed to a housing slowdown, but the banks continue to be rated as among the strongest in the world.

“The idea there will be a banking crisis in Canada is ludicrous,” Rob Wessel, managing partner of Toronto-based Hamilton Capital, told the Globe.

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