It is not a coincidence that the price of crude oil and the value of the Canadian dollar have plunged to multi-year lows as of early 2016, almost in unison. The Canadian dollar has a positive correlation to the price of oil because the commodity is the country's largest export. When oil prices depreciate, the revenue earned from exports decreases. This impacts the health of the country’s economy and therefore the value of its currency. When oil prices appreciate, the opposite event occurs. Revenue from exports increases, the health of the economy improves and the currency appreciates. Investors who are confident that oil prices will rise in the long run can bet on higher oil prices by investing in Canadian dollars.
According to an analysis from Société Générale, the Canadian dollar maintains the highest oil correlation in foreign exchange space over time. Economists consider the Canadian dollar a petrocurrency and a commodity currency.
The Stats
In 2014, Canada was the fifth-largest oil producer in the world. The country is the top crude oil supplier to the United States. Canada holds the second-largest proven reserves of crude in the world. Canada has grown its oil reserves and production rates dramatically in recent years as new technology has improved the cost and efficiency in which oil could be extracted from the Canadian oil sands. There is some sentiment that Canada, proportionally, has oil reserves even closer to those of top-ranked holder Saudi Arabia, as there is reason to question the validity of Saudi Arabia's reserve estimates.
Opportunities
Oil prices declined rapidly after peaking in 2014. The initial descent was due to new supplies flooding the market when demand could not keep pace. As prices fell, producers were reluctant to cut output and instead decided to maintain, and in some cases increase, output to defend their market share. In early 2016, oil prices were less than one-third of what they were at their recent peak, but many market participants are already looking toward the next rally. Oil is a cyclical commodity, and it is only a matter of when, not if, prices will recover.
Those who are confident in a recovery in the future can find a way to profit. Investors who are bullish on the future of crude oil prices can take up a long position in the crude oil futures market. However, investing directly in crude oil futures may be undesirable to some investors. Futures investing is risky, complex, and therefore not suitable for all investors. Fortunately, there are other ways to invest in oil other than directly purchasing oil futures.
Investors who want exposure to fluctuating oil prices without directly buying futures can invest in the Canadian dollar. By betting on an increase in the value of the Canadian dollar, an investor is in essence betting on an increase in the value of crude oil, without having to directly purchase oil futures.
The Future of the Relationship
When planning a long-term investment, it's important to consider whether there will be any fundamental changes to the relationship that created the opportunity before there is the chance to profit. When it comes to the relationship between the value of the Canadian dollar and oil prices, as long as oil exports remain a strong component of Canada’s exports, oil prices will influence the Canadian dollar's value. Given Canada's oil reserves, the fact that demand for oil will persist for years and the country's commitment to advance oil production, its status as a major player in the oil market will remain for the foreseeable future.
