The value of a currency reflects the strength of the economy underlying it relative to other currencies and their respective supporting economies. It’s a function of the most basic relationship in economic theory, supply and demand.

In reality, a strong currency–Canada’s, for example–is often hemmed in by market perceptions of how strength ought to be measured that are conditioned over years, if not decades. In the loonie’s case it’s almost entirely in terms of the direction of the US economy. The US, with whom Canada pairs to form the world’s most significant bilateral trade relationship, is seen as the biggest consumer of Canadian goods. If Americans aren’t buying Canada, nobody is.

The fact is, however, that the Great Recession has exposed and accelerated a long-term shift among the world’s economic leadership that will see emerging Asian nations, particularly China and India, supplant traditional powers atop the global pecking order. And Canada is uniquely positioned among G-7 powers: It enjoys the ballast its relationship with what’s still the world’s most critical economy provides, and it holds the natural resources that rapidly expanding Asian giants need to sustain their growth and keep restive populations from overturning the prevailing political and social orders.

The US-Canada bilateral trade relationship will remain the world’s biggest for some time to come, but the Great White North no longer gets pneumonia when the US sneezes. China and India have seen to that.

The loonie’s relationship with the per-barrel price of crude oil is well understood; prior to the onset of the global downturn it soared well above parity with the US dollar, reaching CAD1.07 per USD1 in November 2007. By March 2009 it had fallen to CAD0.77. Its trajectory mirrors that of oil, which traded above USD145 in the summer of 2008 before falling below USD34 before 2009 dawned.

Amid the peaks and valleys, however, can be seen a definite long-term uptrend that happens to correspond with the ascent of the per barrel price of crude oil to what is highly likely to be a permanently elevated station above USD60 that ranges in the USD80s and tops out in the triple digits. In short, the Canadian dollar is a petrocurrency; what’s bullish for oil prices is bullish for the loonie.

The Energy Information Administration (EIA), the statistics agency attached to the US Dept of Energy, recently released its International Energy Outlook (IEO) for 2010, within which is contained a dramatic change in its forecast for global oil supplies.

As recently as 2007 the EIA estimated oil supplies would increase largely in step with demand. But the new IEO predicts that through 2020, a period during which China will hit its economic growth stride, no year in which liquids production will increase by even 1 percent. Petroleum liquids supply increases by an average of 0.6 percent per year from 2011 to 2020. In other words, the EIA is expecting the oil supply to be essentially flat for the rest of the decade.

The supply will creep up from 86 mbpd today to approximately 92 mbpd to 2020, but that’s not much growth, and indeed, is about the same as current global liquids production capacity. Moreover, it represents a reduction of nearly 4 mbpd from last year’s forecast for 2020. The EIA, considered a cheerleader for production growth, is now one of the most pessimistic production-growth forecasters.

At the same time, strong domestic fundamentals make Canada an attractive destination for foreign capital, and demand for loonie-denominated assets, beyond natural resources, is further supportive of currency strength relative to the US dollar.

And we have more evidence that Canada’s dependence on the US for its economic vitality is receding. Statistics Canada reported Friday morning that 24,700 workers were added to Canadian payrolls in May, trouncing Bay Street expectations for 15,000 new jobs. The gain comes on the heels of a record April, when 108,700 Canadians found work. The unemployment rate remained unchanged in May at 8.1 percent, as more people entered the jobs market.

Of particular importance is the nature of the new additions, which were mostly full-time positions in the private sector. Full-time employment rose by 67,000 in May, while part-time positions fell by 43,000. The private sector accounted for 43,000 new positions during the month, while there were 28,000 fewer self-employed workers.

Average hourly wages rose 2.4 percent in May, and employment has risen by 215,200 over the past five months. Canada’s labor force has increased by 166,000 in 2010, and the participation rate, which fell 1 percent during the recession, has risen 0.3 percent from its recent low. Based on statistics from the first two months of the second quarter, total hours worked jumped “notably” to 4.6 percent annualized, the strongest showing in three years. Meanwhile, wages are up a robust 6.4 percent on an annualized basis, the best showing since the third quarter of 2007.

StatsCan’s news contrasts with what the data the US Labor Dept released Friday morning and provides further illustration of Canada’s reduced dependence on its southern neighbor for economic vitality.

US jobs data for May came in well below expectations, with 431,000 people added to payrolls versus an anticipated 533,000 gain. Particularly disappointing was that gains in private-sector employment of 41,000 were little changed from the prior month. Consensus estimates called for a gain of 540,000 jobs, and analysts expected the private sector would add 190,000 workers. Most of the US job gains were temporary hires by the US government to help conduct the 2010 Census.

The US Federal Reserve is unlikely to boost interest rates until there’s substantial and sustainable expansion of private sector payrolls. Prices can’t go up if people can’t–or don’t have–money to spend. And most Americans still depend on earned income to make ends meet.

Canada’s recent economic news sets the stage for more rate hikes, despite the measured tone the Bank of Canada (BoC) took in its Tuesday statement announcing the country’s first rate hike in nearly three years. The central bank’s outlook on global growth is still cautious, and the statement emphasized that this 25 basis point hike leaves their benchmark rate at 0.5 percent–still not far off the “effective lower bound,” still historically low.

But more people are working, which means they’ll have more to spend. And this means companies will have more capacity to hire. These are the makings of a self-sustaining recovery–as well as the formula for higher prices.

On May 31 Statistics Canada reported that real gross domestic product (GDP) expanded at an annualized rate of 6.1 percent in the first quarter. Canada grew at a rate of 4.9 percent in the fourth quarter. The US economy expanded at an annualized pace of 3 percent in the first quarter. Canada grew faster in the first quarter of 2010 than in any other 12-week period since 1999, a sure reflection of the Great White North’s growing ties to emerging economies in Asia.

As StatsCan noted in an April report, Canada’s short, shallow recession was caused not by disruption of the production and employment cycle but by falling commodity prices in the short term. As the change in the EIA’s stance on oil supply suggests, we’re likely to see higher prices over the long-term.

BoC Governor Mark Carney will base future rate decisions on what’s happening with inflation. But it’s hard to imagine, with numbers like those reported this week, that further action won’t be taken to keep the rate of growth within the target range. It’s hard to argue for a slowdown in domestic demand in Canada anytime soon.

Consumer price levels, job creation and housing sales are all rising in Canada, pointing to a solid recovery. The US is closer to, at least, disinflation than rising inflation. Consumer demand is still weak; in April consumer spending barely rose after six consecutive monthly gains. And unemployment remains stubbornly high. The Federal Reserve is unlikely to begin its rate-hiking cycle until 2011.

Long-term factors such as the soundness of its financial system and its abundant and in-demand natural resources support a strong Canadian dollar. The loonie is likely to resume a flight toward parity with the US dollar (and beyond) that had been interrupted by short-term worries about the sustainability of the global recovery.

The loonie swoons on growth concerns, soars when investors pay attention to the quality of its supports, namely a sound financial system and a tremendous store of natural resources. This makes Canada the ideal play when fear grabs hold of everyone else and causes the irrational cascade. Scoop them up and set them in your portfolio when they get cheap.  

Over the long term the market will realize that the loonie is held up by more than strong crude prices–not that this support is a bad thing particularly in light of the EIA’s assessment of oil production for the next 10 years. Strong domestic fundamentals, coupled with a political and regulatory environment that are an example for the world, make Canada an attractive destination for investment capital.

David Dittman is associate editor of Canadian Edge. He co-authors the complementary weekly Maple Leaf Memo.