During my research, in preparation for an upcoming webminar, I recently stumbled upon a very interesting fact about the CADJPY currency pair. This article is aimed at shedding more light on the pair in question, and also to help spot trading opportunities during periods when commodity prices are trending.
Before I begin, it is necessary to get some basic understanding about the economic forces surrounding the two countries in question: Canada and Japan.
Canada is easily one of the wealthiest nations in the world. In the year 2014, the country had a Gross domestic product (GDP) of $1.992 trillion, and this figure has gone up with its 2015 estimated GDP.
By its GDP, it is among the top 20 largest economies in the world.
The country has a large manufacturing sector, with its primary focus on the Automobile and Aircraft industry. Some of the country’s export goods include air-crafts, motor vehicles and parts, wood, pulp, industrial machinery and petroleum.
According to the International Energy Agency (IEA), as at April 2010; Canada was the sixth largest producer of oil in the world.
With over 150 billion barrels of oil in its reserves, the country is heavily invested in the production and exportation of Oil.
In 2008, the export of petroleum products accounted for the 19% of the country’s entire exports. The oil and gas companies in country also account for about 30% of the Toronto Stock Exchange (TSX), with the energy sector directly accounting for about 7% of the country's GDP.
Just as its Oil production has been on the increase,
so also has the amount of oil the country exports.
From the brief introduction, it is apparent that Canada is an export-dependent country. Because of its oil investments, the country benefits from rallies in Oil prices and commodities. This means that the CAD currency appreciates during oil price rallies, and depreciates when there is a fall in oil prices.
Japan is considered as one of the top five largest economies in the world with a 2015 GDP estimate of $4.210 trillion.
The country is ranked as the third-largest automobile manufacturing country in the world, and is home to great automobile manufacturing companies like Mazda, Nissan, Honda, and Toyota. With the largest electronics goods industry in the world, it is safe to called Japan an economic giant.
Some of the country’s major export goods are motor vehicles, power generating equipment and auto parts. Because of its dependency on exports, the Bank of Japan prefers a situation where its currency is weak, so as to facilitate increased exports with itself trading partners. This desire to have a weak currency has led to several Bank of Japan interventions to devalue its currency.
Most of the country’s GDP is from the service sector which includes services like Banking, insurance, real estate, retailing, transportation and telecommunications. These are all similarities that Japan has with Canada, which also has about 70% of its GDP from the service sector.
The big difference between both countries is that while Canada is a major producer of Oil, Japan is the third-largest consumer of petroleum in the world. The country is the world’s number one importer of liquefied natural gas, and second-largest importer of coal. Japan is a country that is severely lacking in domestic reserves of fossil fuel, and as such the country imports 99% of its oil to meet a large portion of its energy needs.
Canada is a high producer of oil, while Japan is a major consumer and importer. This situation produces a positive correlation for the CADJPY and rallies in oil prices. If oil prices start to go up, the canadian Dollar (CAD) currency appreciates and gains in value, while the exact opposite happens to the JPY currency.
So if oil prices start to rally, a trader would want to go long on the CADJPY pair. It is however advisable not to trade this logic blindly, because the CADJPY does not depend solely on oil prices for its fluctuations. It is very possible that the CAD currency could experience some appreciation, even while oil prices are crashing.
The Canadian economy is a very healthy and robust one; it would take a drop in commodity prices and other economic factors to cause depreciation in the currency. A better approach would be to note the trend in Oil prices, and take advantage of that information on the CADJPY chart.
From the charts below, we see the steady decline of Oil prices from July 2014 till December 2014.
The decline is not mirrored on the CADJPY chart, so rather than shorting the pair blindly, we simply look for short opportunities during the period of declining oil prices.
Other Trading Implications
A large portion of the imported oil used in the United States of America comes from Canada, and this has a direct impact on the USDCAD currency pair.
As the price of crude oil goes down, the CAD depreciates, the USD appreciates, and the USDCAD turns very bullish. The reverse is the case when the price of crude oil goes up. We can see the correlation between the USDCAD trend and the recent decline in oil prices.
Since Oil and gas companies make up about 30% of the Toronto Stock Exchange (TSX), a drop in oil prices affects the stocks of those companies negatively, and consequently the entire stock exchange. If you were an investor interested in investing in the Canadian stock market, an ideal time would be when oil prices are rallying.
The CADJPY currency pair is a unique pair because of the economic importance of oil to both Japan and Canada. The next time oil starts to rally or decline, it is a pair that could offer some profitable transactions.