National Arbitrage: Australia vs Canada

• Posted by DynamicHedge
• on March 7th, 2013

The spread between the two resource-rich countries of Australia and Canada has reached a statistically significant level. These two countries have an economic and statistical correlation which bounds their relative performance. Over the last two years, the Australian ETF has greatly outperformed the Canadian equivalent. It may be time to take a contrarian view and anticipate this spread to revert to the mean.

There are a couple ways to play this relationship. By initiating a short position in EWA and a long in EWC, your trade will be anticipating of the spread reverting to the mean and generating a profit. For those with a positive outlook on the resource sector and longs in Australian companies, you may want to take some profits and cycle some of the capital into Canadian companies looking for the Canadians to play catch-up.

This spread can resolve in several ways: Australia can correct aggressively while Canada just moderately underperforms; Canada can outperform, and Australia can consolidate — or some combination of the two. This type of trade typically takes months to play out, so keep that in mind when planning your timing and position sizing.

Here’s the daily chart:

 

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