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From today's edition of the Financial Post:

A bad time to bet against Canada

Richard Croft
Financial Post

Rumour has it that Paul Martin, the Federal Finance Minister, is feeling pressure from Canadian investors to raise foreign content limits within RRSPs. Best guess has the limits rising to a maximum of 30% of book value phased in over a period of years. Too little, too late?

Many Canadians have already taken matters into their own hands, having jumped on the foreign content bandwagon long ago. This year, RRSP-eligible clone funds have been selling briskly, despite their higher costs.

These "shadow funds" are really bank-issued GICs or other investment attachments where returns are linked to the performance of a well-known foreign mutual fund.

Mind you, these clone funds are really just a new twist on an old theme. For years, Canadians have been able to buy RRSP-eligible index funds that use derivatives to maintain their 100% eligibility.

In both cases, the idea is to gain exposure outside Canada without using up the foreign content room within your RRSP. And with these products Canadians can gain as much foreign exposure as they want, effectively rendering any change to the foreign content rule moot.

That being said, investors may be jumping off the Canadian bandwagon just as our markets start to heat up.

This year, for example, the performance of the Canadian stock market has been red hot. The TSE 100 index is up better than 26.5% (including reinvested dividends) so far this year, compared to just over 15% for the S&P 500 Total Return index -- the two proxies FPX uses for the Canadian and U.S. stock components.

Canadians who opt for a heavy foreign content weighting are also exposed to currency risk. This year's numbers make the point. When you convert the S&P total return into Canadian dollars, it comes in just under 10%. So the strength in the Canadian dollar negated 33% of the total return.

To shun Canada at this point is to leave after 10 years of poor performance relative to the G-7 countries. To play devils advocate, if you sell Canada to buy abroad, are you now selling low to buy high? The only way that makes sense is if you believe that the Canadian market will continue to under perform.

Before you jump to that conclusion, ask yourself why the Canadian dollar has performed so well this year, especially when our interest rates are below comparable U.S. rates. Obviously, foreign investors have faith in Canada.

Often, currency performance is a preamble to the performance of financial markets. Most analysts agree that the strength in the loonie has been tied to rising oil and commodity prices. Because the world believes -- rightly or wrongly -- that higher prices for raw materials are good for Canada. And they may be right.

Canadian oil exploration companies can ratchet up their production schedules, knowing that at these price levels, they can ring up some decent profits competing against members of the Organization of Petroleum Exporting Countries (OPEC) especially if they can generate these profits without triggering inflation.

The U.S. Federal Reserve is concerned about the inflationary impact of higher commodity and oil prices. If those price increases cause a dramatic shift if the consumer price index, look for the Fed to raise rates and dampen economic expansion.

But I'm not convinced commodity and oil prices will cause a major shift in the U.S. consumer price index.

Over the past year, the oil price has doubled, yet there has been no discernable impact on the consumer price index. Productivity increases have more than offset higher prices for raw materials, and that should continue.

Moreover, many analysts, including myself, believe that OPEC is not particularly interested in seeing the price of oil rise much above current levels, for fear of losing market share to non-OPEC countries who can compete aggressively at these price levels.

Given that, it doesn't look as though the price of oil will double again in 2000. If we assume oil prices remain relatively stable in 2000, then most of the impact on the U.S. CPI numbers should already be behind us.

And assuming the U.S. "growth without inflation" scenario continues, Canadian resource companies will be able to keep spinning decent profits without triggering inflation-- the best of all possible scenarios for our economy.

Something to think about as the crusade to increase the foreign content limit heats up.

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