Can you profit from a falling US$
by buying resource shares on non-US exchanges?
Below is an extract from a recent commentary
There's a widely held opinion that you can take
advantage of a weakening US$ by buying your resource shares
outside the US; in Canada, for instance. We'll put aside,
for a moment, our view that the US$ is more likely to rise
than to fall over the coming 6-12 months and look at why this
widely held opinion is logically flawed.
First, let's consider the example of Newmont
Mining, a stock that trades on several exchanges including
the New York (NYSE) and Toronto (TSX) exchanges. Regardless
of what happens to the CAD/USD exchange rate, a US investor
who buys Newmont in Canada will not do any better or worse
than one who buys it in the US because the price of the stock
on each market will adjust to account for changes in the CAD/USD
rate. For example, if the price of Newmont rises by 10% in
Canada and the CAD rises by 10% against the USD then a US
investor who buys the stock on the TSX will make 20% (10%
from the price rise plus 10% from the exchange rate), but
during the same period the price of NEM in the US will rise
by 20% so someone who buys the stock on the NYSE will make
exactly the same amount of profit. In fact, the US investor
who bought the stock in the US would end up doing slightly
better because he/she would avoid the currency conversion
costs (the currency conversion will typically cost you about
1% on the buy and another 1% on the sell).
The inability to gain (or lose) from exchange
rate changes in the example described above is illustrated
on the following chart. The chart compares Newmont Mining's
performance in the US, adjusted for changes in the CAD/USD
rate, with its performance in Canada. There are actually two
lines on the chart, but it looks like there is just one line
because both lines are in exactly the same place.
Many of our readers will consider the above
to be a statement of the obvious, but it's amazing how many
people think their results can be improved by buying a stock
in terms of a currency that happens to be appreciating rather
than buying the same stock in terms of a weak currency.
But what about a resource stock that only trades
in Canada? Could a US-based investor profit from an increase
in the CAD/USD rate by buying such a stock?
The answer is: it's not appropriate to generalise.
If a strong currency provided an automatic benefit to equity
investors then the shares of South African gold miners would
have been the best gold stocks to own during 2003-2004 because
the Rand was the strongest currency in the world during this
period. However, they were actually the WORST stocks to own,
largely BECAUSE the Rand was so strong.
The reason the SA gold stocks performed so poorly
during the aforementioned period is that these companies'
costs were denominated in a strong currency whereas their
revenues were denominated in a weak currency (gold trades
internationally in US dollars). Because the SA Rand was appreciating
at a faster rate than gold, the profit margins of SA-based
gold producers FELL and the resultant fall in their stock
prices was much greater than any benefit a US investor in
these stocks would have received due to the gain in the Rand/US$
The key to profiting from exchange rate moves
when investing in resource stocks isn't to buy the stocks
whose prices are denominated in a strong currency, but, instead,
to buy the stocks of mining companies whose COSTS are denominated
in a WEAK currency. A company that sells gold in US dollars
and incurs most of its costs in terms of a currency that is
weakening relative to the US$ will get a dual boost to its
profit margins in a rising metal price environment.
There are many mining companies that incur most
of their costs outside Canada even though they have their
corporate headquarters in Canada and trade on the TSX/TSXV.
The stocks of these companies have the potential to do particularly
well in the face of a rising CAD, but the bottom line is that
a stock's performance over the long-term will be determined
by its actual and/or projected profits and not by the performance
of the currency in which its shares happen to change hands.
In the short-term almost anything can happen and when traders
feel very optimistic about natural resources it's likely that
most resource-oriented shares will surge, even the ones that
could eventually be hampered by having their costs denominated
in terms of a strong currency.
On a related matter it's important to
understand that when you buy a stock the currency you are
exposed to isn't necessarily the currency that you happened
to use to make your purchase. Rather, the assets of the underlying
company will determine your currency exposure. For example,
iShares Japan (EWJ) trades in US dollars on the American Stock
Exchange, but someone who buys this stock ends up with a long
position in the Japanese Yen, not the US$, because EWJ's assets
are Yen-denominated. If, for instance, the prices of EWJ's
assets were to remain the same while the Yen gained 10% against
the US$ then the price of EWJ would rise by 10%. By the same
token, when you buy gold bullion the currency you use to make
the purchase is irrelevant because what you end up with, in
all cases, is ounces of gold.
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