Investing

Pros and Cons of Investing in Canada

Canada is considered to be one of the safest places to invest in the world. The Canadian landscape is rich in resources, the financial sector is fundamentally sound and our commodity-backed currency is one of the strongest among developed markets.

The Canadian stock market has been handily out-performing other indexes around the globe, with the TSX Composite Index averaging 15 percent growth per year over the past 20 years.

As safe and promising as the Canadian economy appears, there are also plenty of risks for investors. Let’s take a look at the pros and cons of investing in Canada.

THE PROS

Resource rich:

Canada is the largest exporter of minerals in the world and that resource focus has created a thriving mining industry. 60 percent of all public mining companies in the world are listed on the Toronto Stock Exchanges. There are over 3,600 companies listed on the two Canadian stock exchanges, and nearly 1,500 are mining stocks. Another 10 percent are oil and gas companies. Canada also has the world’s largest source of potash, which is necessary for makingfertilizer.

Investors can look to Canada for opportunities to capitalize on the increasing world demand for precious metals, oil and gas and agriculture resources.

Financially sound:

According to a survey by the World Economic Forum, Canada’s banking system is the soundest in the world, indicating that Canada’s major banks are generally healthy with excellent balance sheets. This strong financial position means that Canadian banks now borrow at considerably lower rates than those of many of their international counterparts.

While the six major banks in Canada held off on dividend increases during the financial crisis of 2008-2009, half of them have already raised their dividend this year, with the other half expected to do so by the end of 2011.

Strong currency:

Driven by the recent surge in commodity prices and depreciating US Dollar, the loonie has strengthened and now trades slightly above par with the greenback. Given the current state of the US economy and the increasing demand for Canadian resources, look for this trend to continue in the short term.

Foreign investors purchasing stocks directly on the Canadian exchanges (and thus in Canadian dollars), are not only protecting their investments against the U.S. dollar losing value, they also stand to gain with every small drop of the greenback.

THE CONS

Lack of diversification:

The Canadian market is very poorly diversified. More than 70 percent of the TSX Composite Index is made up of only three sectors (Energy, Materials, and Financials). While there are a few strong utilities and telecoms to choose from across the country, the consumer retail, health care and technology sectors are sorely lacking.

TSX Top 10 Companies by Market Cap

Company Symbol Sector
Royal Bank of Canada RY Financials
Toronto-Dominion Bank TD Financials
Suncor Energy Inc SU Energy
Bank of Nova Scotia Halifax BNS Financials
Barrick Gold Corp ABX Materials
Canadian Natural Resources CNQ Energy
Potash Corp of Saskatchewan POT Materials
Goldcorp Inc G Materials
Bank of Montreal BMO Financials
Canadian Imperial Bank of Commerce CM Financials

Small market:

Not only are the majority of sectors in the TSX under-represented, the Canadian economy is also very small, making up just 4 percent of the global market. As far as diversification goes, investing in Canada is like taking a tiny slice of an already small piece of pie.

With most of your investments concentrated in 3 sectors, you could leave yourself at risk if there is a pull-back in commodity prices, the price of oil drastically falls, or there is a financial crisis similar to what happened in the US a few years ago.

Currency risk:

The loonie has been soaring lately, primarily driven by rising commodity and resource prices. But Canadian interest rates remain at ultra-low levels, and as inflation heats up, this puts the Bank of Canada in a predicament.

If the Bank of Canada raises interest rates too quickly, they risk driving the loonie up even further against the US Dollar which could cripple an already weakened Canadian manufacturing sector that heavily relies on exports. However if interest rates remain at these historic low levels, Canada is at risk for higher inflation and a real estate bubble.

The Canadian economy has been on a tremendous run over the past two decades. ¬†Whether it remains an investor’s haven for the next 20 years depends on whether these pros outweigh the cons.¬†Are you bullish or bearish on investing in Canada?

Robb Engen writes about Canadian personal finance at Boomer & Echo. Together with his mom, (she’s the Boomer, he’s the Echo) they offer their own unique perspectives on saving, investing and personal finance.