Despite this development, Canada is still among the strongest, if not the strongest, of the world’s developed economies. The government hasn’t had to bail out its banks, it has a strong balance sheet, and the country is blessed with significant resources to export once the global economy returns to more normal growth. These factors make “The Canada Trade” highly attractive from a US investor’s perspective.

In its report earlier this week, StatsCan placed much of the blame for the torpor on “lower spending in Canada and the United States, particular business investment in plant and equipment.” This led to a sharp decline in Canada’s exports and imports. StatsCan added that real GDP contracted at an annualized rate of 5.4 percent in the first quarter, compared with a 5.7 percent decline in the US economy. The Bank of Canada (BoC) had forecast a 7.3 percent annualized rate.

The market actually reacted positively to the Monday announcement, seeing the expectations-beating GDP number as yet another “green shoot.” It certainly is another instance of “better but not necessarily good.”

The Australian Bureau of Statistics reported June 3 that Australia’s GDP actually rose by 0.4 percent in the first quarter after contracting by a revised 0.6 percent during the final three months of 2008. The country has thus averted an “official” recession.

Australia’s first quarter GDP growth distinguishes it among most of the Organization for Economic Cooperation and Development. In particular, Canada–like Australia a resource-intensive economy with a relatively sound domestic financial system–reported this week its sharpest two-quarter contraction ever.

The disparity between the resource intensive/financially sound economies is explained largely by export partners: Australia’s conducts most of its trade with Asia; China is its largest bilateral partner. Much of the activity that drove first quarter GDP growth was exports of iron ore and coal to satisfy demand triggered by the Chinese government’s massive stimulus effort.

Canada, on the other hand, still conducts most of its trade with the US, a dependence illustrated by the situation with Ontario’s auto industry, which is really simply a satellite of Detroit. The manufacturing sector, pulled down by a 26 percent reduction in motor vehicle and parts production, accounted for about half of the overall GDP decline in the first quarter.

This highlights a dual imperative for Canada: It must further diversify its economy to account for auto production that’s not coming back and it must diversify its exports to include more Asian destinations, specifically China.

As a February Fraser Institute paper detailed, while China’s share of Canadian trade has tripled since the mid-1990s, only 2 percent of Canadian exports went to China in 2007, while nearly 80 percent went to the US. Canada’s foreign direct investment (FDI) in China is 0.3 percent of its total FDI, while China’s FDI in Canada is just 0.1 percent of its total.

The most obvious areas of potential growth are natural resources–the bulk of Canada’s exports to China at present consist of minerals and forestry products.

Canada is one of the world’s leading exporters of iron ore; China, the world’s biggest consumer, boosted imports of the material to a record 57 million metric tons in April.

And China’s purchases of copper and copper products reached a record 399,833 metric tons last month, up from 374,957 tons in March.

Sinopec (NYSE: SHI) recently purchased an additional 10 percent interest in the proposed Northern Lights oil sands project from Total (NYSE: TOT); the Chinese could make further moves in the oil sands because they believe oil prices will rebound, while the cost of investing has declined from two or three years ago, when the sector was booming. China, now the world’s second-biggest energy-consuming country, increased crude imports by 14 percent in April.

The opportunities to expand the bilateral relationship extend beyond iron ore, copper and oil, however. As China’s Ambassador to Canada Lan Lijun noted in a March 6 speech to the Canada China Business Council-Hong Kong Canada Business Association Luncheon:

Canada is known as an energy superpower, with vast riches in energy resources, and more importantly, home to many cutting-edge technologies in clean energy and environment protection. It is among world leaders in aerospace, information and communications technologies (ICT), wireless technology, and health sciences–areas like biotech, e-medicine and biomedical equipment. Canadian companies with infrastructure and transportation technologies enjoy a long and solid reputation in China.

As my colleague Yiannis Mostrous notes in his June 4 Emerging Markets Speculator column, China won’t save the world. Nor will it rescue Canada. But the reality of a severe global downturn exposes the need for Canada to diversify its economic relationships away from near-total dependence on the US; engaging China more aggressively is now imperative.

While Chinese officials are to some degree leery of Prime Minister Stephen Harper’s Conservative government, they too recognize the vital role Canada can play in contributing to their country’s economic development. In his March 6 speech Mr. Lan also noted:

With crisis comes opportunity. A stronger tri-partnership between China, Hong Kong and Canada is the call of the times.

Trade between China and Canada, however, has fallen short of vast potential for mutually beneficial trade, investment, and broader bilateral opportunities.

The situation with Canada’s Big Five banks is a similar “relativity” story. A 5.6 percent annualized contraction in GDP is bad, but it’s certainly better than the 6.8 percent analysts forecast; across-the-board earnings declines and sharp increases in provisions for loan losses certainly aren’t good, but unlike most of the developed world’s leading banks Canada’s are still profitable, and the writedowns  they have taken are miniscule by comparison to developed-world counterparts.

As a group, the Big Five have made a reputation that continues to earn it “best in the world” mentions in publications such as The Wall Street Journal. Despite taking charges in their capital-markets operations and raising loan-loss provisions in light of a sagging North American economy, the banks beat expectations. And capital ratios remained high across the board, and all managed to rein in expenses.

Profit margins have been hurt during the financial crisis because they’ve had to pay more to obtain funds that they in turn lend out. At the same time, the BoC cut interest rates to record lows. The effect was a squeeze on margins from both ends.

The banks are raising prices on consumer and commercial loans, offsetting some of this pain. Core net interest margins–a measure of the difference between the profits a bank earns from its loans and the amount it must pay to borrow funds–increased from the prior quarter for all the banks, important given that they expect loan growth to slow in coming quarters.

On an individual basis, of course, they have particular strengths and weaknesses.

Toronto-Dominion Bank (TSX: TD, NYSE: TD) reported fiscal second quarter net earnings of CAD618 million (CAD0.68 per share), a 27 percent decline from year-earlier levels. Excluding one-time items, TD earned CAD1.23 per share, above analyst expectations of CAD1.13.

TD roughly tripled its provisions for loan losses to CAD656 million from CAD232 million a year earlier.  TD’s personal and commercial banking operation in Canada had a profit of CAD589 million, up 1 percent on higher revenue and cost cutting. The wealth management business, which includes TD Ameritrade, had earnings of CAD126 million, down 31 percent from last year as mutual fund values were hit by equity market declines. US personal and commercial banking reported adjusted net income of CAD281 million, a decline of 8 percent because of increased provisions for loan losses. Wholesale banking operations had net income of CAD173 million, up 86 percent from the same period last year.

Of the Big Five, TD is the most heavily involved in the US; about half of its retail branches are located south of the border, albeit in regions relatively unscathed during the housing downturn. As is the case for all of the banks, if the economy performs worse than expected, loan-loss provisions won’t be sufficient, and losses could get a lot worse.

Royal Bank of Canada (TSX: RY, NYSE: RY), like TD, has been increasing its presence in the US in recent years, primarily in the Southeast. This region has been hit hard in the real estate downturn; RBC posted its first lost since 1993 after taking a previously announced CADD1 billion writedown on goodwill associated with the declining value of loans held by its US operations.

In the three months ended April 30, Canada’s largest bank had a net loss of CAD50 million (CAD0.07 per share). A year ago the bank made CAD928 million (CAD0.70 per share). Excluding the goodwill charge and other one-time items, RBC came out ahead of analysts’ expectations with a profit of CAD0.97 a share.

In the recently concluded fiscal second quarter, RBC’s US operation had about USD3.3 billion worth of mortgage loans, USD4.6 billion in home equity loans and USD1 billion in development loans.

Bank of Nova Scotia’s (TSX: BNS, NYSE: BNS) net income fell 11 percent to CAD872 million (CAD0.81 per share) in the three months ended April 30, an 11 percent decline from the CAD980 million (CAD0.97 per share) earned a year earlier. The reduced profit came despite a 12 percent increase in revenue from the year-earlier period to CAD3.7 billion on higher net interest income, strong capital markets revenues, and gains due to foreign currency translation. Core cash earnings came in at CAD0.83 per share versus a consensus forecast of CAD0.78.

Scotiabank boosted its credit provisions by 220 percent, the most among the Big Five, to CAD489 million. This figure includes a CAD60 million “sectoral allowance” for the bank’s exposure to auto loans. During Scotiabank’s earnings conference call, management said restructuring General Motors (NYSE: GM) and Chrysler represent 11 percent of the bank’s total exposure to auto dealers.

Moody’s changed its outlook on Bank of Montreal’s (TSX: BMO, NYSE: BMO) Aa1 rating to “negative” from “stable” following the bank’s earnings announcement. The ratings agency cited rising loan losses and BMO’s reliance on capital markets to fuel earnings. “BMO’s business mix has a material weighting towards capital markets activities in general, and structured credit activities specifically, which is likely to result in continued earnings volatility,” Moody’s said.

Canada’s fourth-largest bank posted a net profit of CAD358 million (CAD0.61 per share), down 44 percent from the same period last year. The personal and commercial banking operation in Canada reported net income of CAD350 million, up 9 percent from a year ago. BMO’s US operation posted net income of CAD21 million, down 30 percent from a year ago. The bank’s capital-markets division had net income of CAD249 million, up 33 percent from last year. BMO set aside CAD372 million to cover loan losses, up CAD221 million from a year ago but still lower than analysts had expected.

Canadian Imperial Bank of Commerce (TSX: CM, NYSE: CM) continues to struggle with its structured-credit exposure, although CEO Gerald McCaughey said that while losses here had hurt results, they occurred early in the quarter, before the market improved.

CIBC posted CAD475 in pretax writedowns, leading to a CAD51 million (CAD0.24 per share) loss for the period, narrower than the CAD1.11 billion of a year ago. Excluding items, CIBC reported earnings of CAD1.44 a share, besting a consensus forecast of CAD1.39 a share.

CIBC set aside CAD394 million to cover credit losses, up from CAD176 million a year earlier. The bank’s large credit card portfolio has been hit as consumers struggle to pay their bills with unemployment rising.

CIBC’s exposure to credit default swaps, collateralized debt obligations and other so-called toxic credit derivatives that have lost much of their value has left it more vulnerable than its peers. CIBC was also a player in the CAD35 billion market for third-party asset-backed commercial paper (ABCP), which was recently restructured after an 18-month freeze-up, both as a dealer and an originator of credit derivatives underlying some of the notes. The bank said it had a pre-tax gain of CAD8 million after terminating a credit default swap deal underlying the restructured ABCP, one of the few bright spots in its structured credit experience.

The condition of the US and the global economy is the wild card for Canada and its major banks, though clearly not for lack of government efforts elsewhere. Fiscal and monetary officials all over the world have set aside billions for new spending and slashed benchmark interest rates in some cases literally as low as they can go. The (BoC), for example, held its benchmark rate at 0.25 percent Thursday, indicating in its statement announcing the decision that it would like keep it at this level into 2010.

Canada is rich with in-demand commodities, and it’s fiscally sound, registering its first budget deficit in 12 years, one that’s still miniscule compared to other G-8 countries.

The Canadian dollar is a strong store of value because of oil, coal, iron ore, potash, etc., and it looks good relative to the global reserve currency because the federal government, under both major parties to control it in the recent past, has demonstrated a commitment to balancing the books. And the BoC won’t be firing up the press to print more loonies.

Major indicators–in Canada, the US, China–suggest a turn to growth may be afoot. And, as the commodity-price surge and related rise in the loonie versus the greenback of recent weeks indicates, renewed growth means rising demand for resources. As the BoC noted in this week’s interest rate statement, there’s some concern that a strong currency will hinder Canada’s exports, but in both absolute and relative terms, Canada looks much better than other developed economies, with a manageable debt level and a strong inventory of raw materials available to a recovering global economy.