Correction: Forex Tailwind Easier Than I Thought

My recent article on nabbing extra gains on Canadian stocks if the US dollar (USD) weakens compared to the Canadian dollar (CAD) was partially incorrect.

The tailwind itself is real enough. If the Canadian dollar rises compared to the US dollar, that would add to the gains of investors in CAD-priced equities.

What I got wrong was based on leftover thinking from when it was trickier to buy Canadian stocks in the US. Contrary to what I said, the tailwind does not apply only to stocks bought in Canada with funds sent there at one exchange rate and then recovered after the sale at another exchange rate. Because arbitrage players communicate price changes across the border, the extra gains apply wherever the shares are bought and in whatever currency.

Here’s an example I gave a reader who asked about this:

1. At the start, 1.0 CAD = 0.7 USD.
2. I take $1,000 USD, buy $1,300 CAD.
3. I use the $1,300 CAD to buy 1,300 shares at C$1 each.
4. The Canadian dollar rises, so 1CAD=1USD.
5. At the same time, the shares double to C$2.
6. I sell and net C$2,600, which I can now exchange for US$2,600.
7. The stock doubles, but my investment more than doubles.

That’s not wrong, but every day the Canadian dollar rose, those shares would be worth a little more in USD, and so the US price would rise a bit more as well. If it didn’t, people could buy the shares in the US and sell them in Canada at a profit. This arbitrage opportunity would quickly close the gap.

Here’s how my example would look buying in the US:

1. At the start, 1.0 CAD = 0.7 USD.
2. The shares at C$1 sell for US$0.70 in the US.
3. My US$1,000 still buys 1,300 shares.
4. The Canadian dollar rises, so 1CAD=1USD.
5. At the same time, the shares double to C$2—which is now US$2.
6. I sell and net US$2,600.
7. The stock doubles, and my investment more than doubles—but without the fees I would have paid buying and selling Canadian dollars.

I stand corrected and thank my astute readers for pointing this out.

Note that for this second example to work, the same stock needs to trade in the US with good liquidity. That was a rare thing in past decades. Access is much better today, but liquidity is still a concern. In a bear market, the volume for Canadian stocks on the US “pink sheets” (where most people buy foreign stocks that don’t have a proper US listing) will drop to zero long before it does in Canada.

Whether it’s buying Canadian stocks in the US, or Australian stocks in London, or whatever combination we like, we need good volume and low trading costs for this to work. And if we don’t have access to the foreign stocks we want on our domestic exchanges, we still need to go to those markets and trade there.

There are other important considerations:

• Having a Canadian broker or two is essential to getting in to great private placements in Canadian junior resource companies. The same is true for other countries.
  
  
• Diversifying assets across different political jurisdictions is a critical part of how an International Man like Doug Casey manages his country risk. With increasing capital controls worldwide and things like the EU sanctioning “bail in” seizures of individual savings accounts, this is an increasingly important issue.

Yet the fact remains that if we can buy stocks denominated in a currency that rises versus the currency of the country where we trade, we can reap extra gains on our investments.

Just remember that the reverse is true as well when the currency exchange rates go against us.

If you’re going to chase after this tailwind, you have to be very sure which way exchange rates will change—and understand that you’re speculating.

Caveat emptor,