Why is the Canadian Dollar Not Strengthening?

I devote a lot of attention to inter-market analysis in the Forex Point and Figure System (FxPnF). In fact, I dedicate an entire chapter in the book to the discipline of inter-market analysis.

Inter-market analysis is essentially looking at one market in an attempt to gain an edge in another market. The forex market is the most applicable market in which to conduct inter-market analysis because of the nature of pairs trading and the nature of fiat currencies.

A classic example of inter-market analysis is to buy the currencies of countries who export crude oil when oil prices rise. According to the Central Intelligence Agency (CIA), the top exporters of crude oil are: Saudi Arabia, European Union, Russia, Norway, United Arab Emirates, Iran, Canada, Mexico.

The Saudi riyal is a fixed exchanged rate, pegged to the U.S. dollar at 3.75 riyals. The European Union imports much more oil than it exports, so the euro isn't a good currency to trade based on oil prices. The Russian ruble isn't liquid. The Norwegian krone is the purest play on crude oil prices, but the currency isn't available for trading through a lot of forex dealers...yet. Neither the UAE dirham nor the Iranian rial are liquid or available. Among the currencies of the biggest oil exporters, the Canadian dollar is the most liquid. Behind the Norwegian krone and Loonie, the Mexican peso is the third best currency with which to play oil.

One of the best ways to the play the Canadian dollar and it's connection to oil prices is through the USD/CAD. That's because oil is priced in U.S. dollars globally, although there have been some moves to price oil in euros in certain parts of the world. As it stands today, oil is still predominantly priced and traded in dollars. So, when the dollar weakens, oil tends to rise; conversely, a strong dollar generally leads to a drop in oil prices.

The USD/CAD, being the proxy for oil that it is, reached a multi-decade low of near 90 cents last November. The Canadian dollar was soaring as crude oil prices approached $100 per barrel in early November. But something happened late last year to break the inter-market relationship between crude oil and the Canadian dollar.

You see, crude oil is trading well above where it was last November, when the USD/CAD was down near 90 cents. Crude oil has since risen by about $15 per barrel, but the USD/CAD has actually moved higher, meaning the Canadian dollar has weakened.

The Canadian dollar's weakness isn't specific to the USD/CAD pair. You can observe general weakness in the CAD across the EUR/CAD, CAD/CHF, CAD/JPY, AUD/CAD, etc.

Returning to the USD/CAD, the pair has gyrated around par (1.0000) since rebounding from 90 cents late last year. Meanwhile, oil has moved increasingly higher, reaching a new record today! Yet the CAD is not strengthening. Why?

It's more important to consider why the CAD isn't strengthening than to actually answer the question, or to find a justification for the recent breakdown in the inter-market relationship. By simply observing the breakdown in the relationship, we might be able to gain an edge and spot an opportunity in the USD/CAD, or any other CAD-related pair, in the coming weeks and months. My first inclination is to short the CAD vis-?-vis a long USD/CAD position because the CAD has lagged the most recent rise in crude oil prices. My thinking is that if crude oil at $113 can't strengthen the CAD, what will? But I'd like to see some weakness in crude oil before executing the trade.

Of course the other opportunity that might arise from the recent breakdown in the relationship between crude and the Canadian dollar is a rebound in the CAD. The CAD could play catch-up to crude oil, which would mean a significant decline in the USD/CAD. But I won't get interested in shorting the USD/CAD until it at least breaks down below 99 cents.

Either way, I can afford to be patient and wait for the right signal because when it comes, there should be an easy, long-lasting trend to follow. Whenever I've seen a breakdown in strong inter-market relationships, such as the linkage between the CAD and crude, it's usually a precursor to a big economic or government policy change and, consequently, a big move in the currency.

My hunch is that the CAD is going to weaken, and by a lot, but I'm going to be patient and wait for the signal before placing a trade on just a hunch. The 50 and 100 pip box size charts are good point and figure charts to watch over the coming weeks and months. We should see an obvious signal on one, or both, of these charts.

Eric is a former forex industry indsider. He's been trading stocks, options, bonds, futures, and forex for over a decade. He first learned about point and figure charts in 2000 and has since become an expert in the method. He now applies point and figure charts to his forex trading. You can learn more about the FXPNF System by visiting: http://www.fxpnf.com