Canadian Dollar Selling Opportunity at $.80 to the U.S. Dollar

The Canadian Dollar is primarily a commodity based currency. Whether the commodity is being extracted, processed or exported, the commodity itself touches a lot of Canadian hands on its way out the door. As such, it's not surprising that the recent commodity rally has sparked a bid in the Canadian Dollar just as the oil and grain washout contributed to its oversold condition at the beginning of this year. This week, we'll look at some fundamental background, then illustrate the current situation and the setup we see coming on the included Canadian Dollar weekly and daily charts.

We'll begin with the broadest of brush strokes. The natural resource sector accounts for approximately 20% of the Canadian economy. Clearly, the development and implementation of fracking technology over the last decade or, so has contributed greatly as the energy sector now accounts for half of the total natural resource sector as shown on the chart below.

One of the primary indexes used to measure commodity production in Canada is the transportation sector. According to the World Bank, Canada has 4 people per square kilometer as compared to the United States at 35 people per square kilometer as compared to second on the list, Monaco at nearly 19,000 people per square kilometer. The point is that Canada has a LOT of land and a LOT of natural resources but NOT a lot of people. Therefore, the transportation sector is a primary artery in the Canadian economy due to the percentage of people in the production and transportation chain.

As you can see on the chart above, the Canadian transportation inflation index has been trending lower since last July as commodity demand and energy prices have waned. Worse, declining revenues have led to historically high employment costs.

It's never been more expensive for Canadian companies to hire.

Obviously, increasing employment costs in a stagnating economy leads to lay-offs. Tragically, many of the lay-offs will combine to prick the Canadian housing market bubble but, that's a story for another day. Anecdotal evidence is already showing up as Canadians are traveling less and generally enjoying less recreation. There have been fewer Canadians at the winter resorts and fewer Canadian boats appear to be hitting the water in our area of Western Lake Erie, which had begun to take on the name, "Canadian Riviera" over the past 10 years.

While the Canadian unemployment rate dropped .2% last month, the trend is certainly appears to be heading higher.

I think we've established the basis for our bearishness on the Canadian economy. Now, let's move to the actual Canadian Dollar charts. First, we'll look at the weekly chart. We've set this up pretty similarly to our standard Commitments of Traders chart. The Canadian Dollar weekly data is in the top pane, followed by our market trigger, commercial trader momentum and finally, the current net position of the three major trading groups - commercials, large speculators and small speculators. Our primary area of focus are the areas where the large speculator position outgrows the commercial trader position on a net basis. The vertically shaded sections in the chart below highlight these areas. Each time the large speculator net position has outgrown the commercial trader net position, the market has turned. We expect this type of behavior to continue.

Each time the large speculator position has outgrown the commercial net position, the market has turned lower and flushed out the large specs.

The cyclical behavior between the commercial traders and the large speculators is a recurring and exploitable theme in commodity trading. Their interaction is the basis for our work at CotSignals and this brings us to the current daily chart, below.

This is our discretionary COT overlay. You can see that the current rally has become overstretched in the face of an increasingly bearish commercial trader population.

Very simply, we look for short selling opportunities when the commercial traders are bearish based on their own analysis. Then, we add our own layer of exhaustion scouting in order to fine tune our entry point to match the wallet of the retail trader rather than attempting to place our retail Dollars at risk on a weekly chart. Furthermore, the exhaustion point we're looking for will provide us with a chart based point at which we can logically place a protective buy stop. All of this means that we're looking for the Canadian Dollar to reverse near $.80 to the Dollar. Once we get the reversal, we expect to trigger both mechanical and discretionary trades on the short side as we believe the fundamentals at play, along with the overbought nature of the market's current rally will cause the market to fall substantially.