Last year was a strong one for the Canadian dollar (loonie). After a 16% gain against the U.S. dollar (USD) in 2009, it added another 5.5% last year. This is the strongest it's been since 2008, and that strength is directly tied to rising prices for crude oil and commodities. Canada's vast supplies of natural resources provide solid support for the currency as prices for commodities have risen across the board in the past year. Also, the United States imports more oil from Canada than any other country. (For more, see Canada's Commodity Currency: Oil And The Loonie.)
On December 31, 2010, the loonie closed at 99.8 cents to the USD, the first time it's finished a year above parity since 2007. Additional support for the currency came in November when Russia began purchasing the loonie to diversify its foreign exchange reserves. The loonie gained against seven other major currencies during the past year. It performed best against the Danish krone (+13%) and worst against the Japanese yen (-8%), according to Bloomberg.

IN PICTURES: Break Into Forex In 12 Steps

After the loonie was floated against world currencies in 1970, it became a benchmark and global reserve currency. There has always been a close relationship between the movements of the loonie and USD, and the relative economic conditions in both countries. The link between the tandem has decoupled over the past 10 years, primarily as a result of the rise in oil and other commodity prices.

The importance of the relative strength of the two currencies can't be overstated since the countries are major trading partners. Over three-quarters of all Canadian exports go directly south of its border, and over half of Canada's imports come from the United States.

Buying Power
For Canadians, the higher loonie is a drag on exports because they appear more expensive to importing countries. If demand for gasoline in the United States was highly elastic, this would hurt Canadian crude exports. The reality is that, at current prices, gasoline demand is relatively inelastic so the rise in the loonie has not negatively impacted Canada's oil exports. Data from the U.S. Energy Information Administration shows that imports of oil from Canada averaged 1,919,000 barrels per day during the first 10 months of 2009. In comparison, an of average 1,962,000 barrels per day were imported during the first 10 months of 2010.

Canadian companies that import raw materials, machinery and other American products benefit from the stronger loonie. Retailers that specialize in American imports have the option of lowering prices and increasing sales volume, or maintaining prices and increasing margins. The reverse is true for American importers since they pay more for Canadian products.

The stronger loonie is good news for American exporters who have struggled through the recession of the past few years. Their products appear cheaper to Canadian companies and consumers, helping their bottom lines. American exporters also have the option of reducing their prices with the goal of increasing sales revenues through higher export volume. (To learn more, check out our Economics Basics Tutorial.)

IN PICTURES: 5 Investing Statements That Make You Sound Stupid

Doing Business
Canadian businesses that want to expand into the United States now get more bang for their investment buck. The stronger loonie provides them with more purchasing power for potential acquisitions. It also helps Canadian companies that do business in Canadian dollars but pay salaries in USD, such as Canadian sports franchises that operate across the border (think professional hockey teams).

Going Forward
Based on a Bloomberg survey of 29 economists, the loonie is expected to trade between parity with the USD and C$1.01 for the rest of this year. Much depends on the state of the U.S. economy, which has been battered by the implosion of a housing bubble and rising government debt. The monetary policies of the Federal Reserve are widely viewed as being inflationary, which could put further downward pressure on the USD. While the Fed could raise interest rates to fight that trend, this could stall or derail an already weak economic recovery which would likely spill over into Canada.

The Bottom Line
The key fundamentals that have strengthened the loonie are investor risk tolerance, a stable and growing Canadian economy, a good fiscal balance sheet, higher commodity prices and a search for investment currencies that will hold value in the future. (To learn more, see Why Things Are Getting A Little Loonie.)

For the latest financial news, check out Water Cooler Finance: You're Never Too Old To Work.

Related Articles
  1. Investing

    What a Fed Delay Means for the ECB & BoJ

    The Fed’s continued delay has repercussions for more than just the U.S. economy and markets. The ECB and the BoJ may support the case for stocks in Europe.
  2. Investing

    How Worried Should We Be About China?

    An economic slowdown, a freezing up in trade and plunging markets and currencies are casting a shadow across Asia—and the globe. How worried should we be?
  3. Economics

    Keep an Eye on These Emerging Economies

    Emerging markets have been hammered lately, but these three countries (and their large and young populations) are worth monitoring.
  4. Investing Basics

    Learn How To Trade Gold In 4 Steps

    Trading spot gold or gold futures, equities and options isn’t hard to learn, but the activity requires skill sets unique to these markets.
  5. Economics

    The Effect of Fed Fund Rate Hikes on Gold

    Explore the historical relationship between interest rate increases and the price of gold, and consider what effect a fed funds rate hike might have on gold.
  6. Investing

    Latin America’s Economic Forecast

    After a ten-year run, the economies of Latin America are in a decline. For sustainable, long-term growth, the region needs structural reforms.
  7. Mutual Funds & ETFs

    Top 3 Commodities Mutual Funds

    Get information about some of the most popular and best-performing mutual funds that are focused on commodity-related investments.
  8. Chart Advisor

    Agriculture Commodities Are In The Bear's Sights

    Agriculture stocks have experienced strong moves higher over recent weeks, but chart patterns on sugar, corn and wheat are suggesting the moves could be short lived.
  9. Investing Basics

    Learn How To Trade Crude Oil in 5 Steps

    Crude oil and energy markets are specialized venues. Here are five steps to take to build consistent profits.
  10. Forex Education

    The Most Famous Forex Traders Of All Time

    The five most famous forex traders share common virtues such as strong self-confidence.
  1. How are NDFs (non-deliverable forwards) priced

    The price of non-deliverable forward contracts, or NDFs, is commonly based on an interest rate parity formula used to calculate ... Read Full Answer >>
  2. What are the goals of covered interest arbitrage?

    The goals of covered interest arbitrage include enabling investors to trade volatile currency pairs without risk as well ... Read Full Answer >>
  3. What is the difference between a Nostro account and a regular bank account?

    The term nostro account is a bit of an umbrella term and can have different meanings for different contexts. For instance, ... Read Full Answer >>
  4. What kinds of costs are included in Free on Board (FOB) shipping?

    Free on board (FOB) shipping is a trade term published by the International Chamber of Commerce or ICC, that indicates which ... Read Full Answer >>
  5. What types of companies benefit from reporting results utilizing constant currencies ...

    Any company that does a substantial amount of business in foreign countries, and is therefore subject to foreign currency ... Read Full Answer >>
  6. What are the differences between B-shares and H-shares traded on Chinese stock exchanges?

    Equity listings in China generally fall under three primary categories: A shares, B shares and H shares. B shares represent ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Real Estate Investment Trust - REIT

    A REIT is a type of security that invests in real estate through property or mortgages and often trades on major exchanges ...
  2. Section 1231 Property

    A tax term relating to depreciable business property that has been held for over a year. Section 1231 property includes buildings, ...
  3. Term Deposit

    A deposit held at a financial institution that has a fixed term, and guarantees return of principal.
  4. Zero-Sum Game

    A situation in which one person’s gain is equivalent to another’s loss, so that the net change in wealth or benefit is zero. ...
  5. Capitalization Rate

    The rate of return on a real estate investment property based on the income that the property is expected to generate.
  6. Gross Profit

    A company's total revenue (equivalent to total sales) minus the cost of goods sold. Gross profit is the profit a company ...
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!