A: Thanks for your question!
We will investigate it, using the back-of-the-envelope type econometric method that we used in Is the Value of the Canadian Dollar related to Oil Prices?. Specifically, we will do the following:
First we need some data. For Canadian Data, a good list of resources is available at "Where can I get data on the Canadian economy?". I need two types of data - one on exchange rates and the other on oil prices.
To get the Canadian-American exchange rate I went to The PACIFIC Exchange Rate Service and choice "Canadian" as the base currency and "American" as the target currency. I chose to look at daily data from the time period January 1, 2006 to May 22, 2007. I then downloaded this into Excel format.
To get U.S. dollar oil price data I went to the U.S. Energy Information Administration and downloaded their Crude Oil Prices in Excel format.
As before, I first calculated the correlation coefficient. In the period between 2002-2005 the correlation between daily movements in oil prices and daily movements in the Canadian dollar was quite high, at 0.8477. For the more recent 2006-May 2007 period, the correlation was much lower at 0.5671.
I also ran a linear regression, to investigate the relationship between the Canadian Dollar and oil prices, which was found to be as follows:
CDN DOLLAR = 0.7641674 + 0.001766*OIL PRICE
With a calculated R2 of 0.3216, meaning that 32.2% of the variance in the Canadian-American exchange rate is "explained" by the variance in oil prices. It is important to note that this does not tell us that oil prices are causing changes in the exchange rate, only that the two factors move in tandem.
There are clearly other factors at play here. To get a feel for the data, I plotted the actual exchange rate to what the model predicts the exchange rate "should be" given oil prices. The results were quite illuminating.
Over the last 2-3 months, oil prices have fluctuated, but overall they have risen by only a few dollars. However, the Canadian dollar has risen steadly, from .848 on March 7th to .921 on May 22nd. Our model does not predict this. I thought the model from Is the Value of the Canadian Dollar related to Oil Prices?, which has a much stronger relationship between oil prices and the Canadian dollar, might explain this link, but it does not as well. For oil prices to be causing this level of increase, we would need each dollar increase in the price of oil to be causing a rise in the exchange rate by .024; much larger than the 0.001766 and 0.005 predicted by this article and the previous one. There are likely other factors at play here.
Next week we will examine those other factors and test them to see if they can help explain the rapid appreciation in the Canadian dollar.
