Like the US, Canada has felt the impact of the worst global recession in decades. The country’s economy has contracted, pushing up unemployment to its highest level in many years, led by a continued slump in manufacturing.

This recession has had a particularly severe impact on prices of raw materials. The main reason is the world’s biggest market for most natural resources, the US, has sharply curtailed its appetite for everything from zinc and lumber to natural gas. As a result, the North American forestry market has all but collapsed, as has natural gas and oil drilling.

In years past that would have had a devastating impact on Canada’s economy. In fact, the generational collapse of commodity prices across the board in the 1980s did trigger a nationwide slump that kept large pieces of the country’s economy in the doldrums up until early this decade, when resource prices finally bottomed and began heading higher once more.

Ironically, this time around Canada has proven positively resilient compared to the vicious downturn occurring in the US and elsewhere. Canadian GDP has declined in recent quarters. But the rate of decline has been a fraction of the 6 percent meltdown we saw in the US during the fourth quarter 2008 and first quarter of 2009.

Canadian GDP came in flat for July, prompting its central banker to declare its recession ending. Meanwhile, the country actually reported a surprise gain in the number of jobs, as well as a sequential gain in wages. That, too, is a stark contrast with the US. And it’s yet another sign of Canada’s growing ability to stay afloat even with its southern neighbor in grave difficulty.

Perhaps most surprising of all has been the performance of the country’s real estate market. At a time when US residential and commercial property values are crashing and burning, Canada’s market has staged a dramatic recovery from the lows reached at the end of 2008.

According to the Canadian Real Estate Association, August 2009 home sales are a sizzling 18.5 percent above year-ago levels, while home prices are up 11.3 percent nationally.

Although the volume of commercial real estate transactions is still off sharply, that’s in large part because prices haven’t fallen far enough to encourage distressed sales, again a sharp contrast with the floundering US market.

Key beneficiaries of Canada’s strong property market include our favorite Canadian real estate investment trusts: Artis REIT (TSX: AX-U, OTC: ARESF), Canadian Apartment Properties REIT (TSX: CAR-U, OTC: CDPYF), Northern Property REIT (TSX: NPR-U) and RioCan REIT (TSX: REI-U, OTC: RIOCF).

In stark contast to US REITs, all continue to report strong occupancy rates and rent growth. While US REITs have cut dividends at an unprecedented rate, Canadian REITS continue to cover theirs handily with distributable cash flow.

Canada’s banks get a great deal of credit for the country’s resilience. Canadian financial institutions largely avoided the temptation of subprime lending, instead maintaining high credit quality standards. That’s paid off with robust health, as we point out in our sector review in the September 2009 Canadian Currents.

With the country’s six largest banks consistently maintaining superior capital ratios, they’ve been able to keep capital flowing to Canadian businesses. That’s included oil and gas producers, which have seen their cash flows hit hard by sliding energy prices.

Rather than pull the plug to salvage badly needed cash, Canadian banks have been able to take a long-term perspective based on reserve values. The result is producers have been able to keep projects going through the downturn and are poised to profit coming out the other side.

Strength of financial institutions, however, is only half the story behind Canada’s unexpected strength during this crisis. The other is the country’s steady reduction of its dependence on US markets for exports in recent years.

Eastern Markets

Despite the occasional squabble–the most recent over “Buy America” provisions inserted by Congress into President Obama’s stimulus package–the US remains Canada’s biggest and best trading partner. That’s a special relationship that’s spanned centuries, made indelible by geographic proximity and cultural ties.

Moreover, while it’s fallen off sharply during the recession, bilateral trade between the US and Canada has grown markedly under the North American Free Trade Agreement (NAFTA), still one of the most successful pacts ever signed. By the time Canadian exports to the US peaked in July 2008, they were 30.9 percent higher than the year earlier and more than three times levels of 1993, the year NAFTA was ratified.

The US, however, is no longer the only market for Canadian exports, the only source of new products or the sole font of new investment. Rather, its share of all three has been steadily shrinking due to even faster growth in Canada’s trade and investment with other nations.

In 2003, for example, the US was the market for a full 85.7 percent of Canada’s exports. By 2008, that percentage had fallen to 77.7 percent, despite growth of 15 percent in total trading volumes. The US share of Canada’s total merchandise trade, meanwhile, had shrunk to just 65.7 percent in 2008, down from 74 percent. And it’s contracted further still in the face of the recession.

Who’s been filling in the gaps? Europe has always been a key trading partner for Canada, and Germany has now emerged as the country’s second-leading partner. Cultural ties with the mother continent are strong, and there are numerous relationships between companies in everything from power generation and energy extraction to technology.

European trade, however, doesn’t account for the decline of the US share of Canada trade. Rather, that’s due to burgeoning demand for Canadian products from Japan–now the country’s No. 3 trading partner–and the developing world, particularly China.

What does China see in Canada? For one thing, Canada is a market for its manufacturing exports, running a trade deficit with China like much of the world.

Second, at a time when resource nationalism and protectionism are on the rise globally, Canada is still a favorable place for direct investment. And finally, Canada is a storehouse of natural resources that China increasingly covets as its economy expands.

China’s share of Canadian exports was just 1.3 percent in 2003. By 2008, that percentage had nearly doubled on a 115.7 percent volume increase. And with China’s appetite for resources only increasing, that number is set to continue rising at a torrid pace in coming years.

China’s emergence as a major market for Canada’s output still isn’t large enough to wholly offset the massive drop in US demand that’s taken place since mid-2008. But it is on the move, and its needs span almost every major agricultural, energy and mineral commodity.

China’s imports of refined copper and iron ore, for example, hit record levels in the first four months of 2009. That’s a direct result of accelerating industrial activity due to the government’s aggressive infrastructure spending program. A recovery in the domestic housing market has also pushed up demand for metal-intensive appliances.

Chinese demand is showing up in an increase in Canada’s raw export volume of commodities and resource-based manufactured products. These accounted for 44.3 percent of Canada’s merchandise exports from 2003 to 2007. In 2008, that surged to 50.9 percent primarily due to surging energy prices, which made up almost a quarter of the total.

This January China overtook Germany to become the world’s third-largest economy. At current growth rates–which this recession has proved are well-supported by the country’s government–China will surpass No. 2 Japan within three to four years.

And barring unforeseen obstacles to growth the country will actually overtake the US by 2030 to become the world’s biggest economy.

Even if that happens, the US will still almost certainly remain Canada’s most important market and trading partner.

In fact, I’ll venture to say America will almost certainly be a primary beneficiary of China’s continued growth, as US companies expand investment and the volume of trade between our two countries continues to grow.

Ag Growth International (TSX: AFN, OTC: AGGZF) is one trust well-positioned to profit from this inexorable trend, as China is a major market for US corn farmers, who are its core customers.

Chinese growth, however, is going to require a phenomenal amount of natural resources, as the country urbanizes and begins to support what will inevitably become the world’s biggest middle class. The government well knows this and has been active in building and maintaining strategic stockpiles of resources to ensure adequate supplies at affordable prices to support growth.

This rapid growth will only be possible if China can secure sufficient resources to support infrastructure improvements and the development of a Chinese middle class. And that spells accelerating demand for Canada’s raw materials, including energy.

China Takes Stock

The other major way China is getting involved in Canada is direct foreign investment. It’s pretty clear at this point that China’s leadership will do everything possible to sustain the 8 percent rate of growth, no matter what’s going on in the rest of the world. Anything less will simply not support populations migrating from rural areas to urban centers.

The government is prepared to do this with massive stimulus spending at home, with a package passed in November equal to 45 percent of the country’s total GDP. And it’s prepared to do what it takes to secure the needed resources abroad with aggressive investment from sovereign wealth funds and government-backed corporations.

At the same time China is attempting to secure more resources to fuel its economic growth, resource nationalism is on the rise around the world, in many cases thwarting its efforts.

In September, major Chinese oil company CNPC was forced to walk away from a deal to buy Verenex Energy (TSX: VNX, OTC: VRNXF) after the Libyan government refused to approve the deal.

Verenex, owned 45 percent by Vermilion Energy Trust (TSX: VET-U, OTC: VETMF), later accepted a lower bid from Libya’s state-owned oil company. This failure follows others around the world, as national governments have thwarted the country’s efforts to lock up resources.

In contrast, Canada currently presents no such obstacles and Chinese companies are taking advantage to make purchases. PetroChina (NYSE: PTR), for example, last month announced a CAD1.9 billion purchase of a majority stake in two oil sands projects in Alberta from developer Athabasca Oil Sands Corp.

The purchased projects won’t come on line until 2014 and are estimated to be economically viable only at an oil price of at least USD50 to USD60 a barrel. That’s a pretty clear indication of the long-term focus of Chinese investing in Canada’s resources business. For investors, it’s a focus that argues for more purchases in the future at good prices.

And PetroChina’s hardly the only Chinese entity making investments. Sinopec (NYSE: SNP) has been active acquiring Canadian assets as well, locking down a 10 percent stake in the Northern Lights oil sands project.

One of the largest deals to date between Chinese and Canadian resource companies is the acquisition of a 17 percent stake in Teck Resources (TSX: TCK-B, NYSE: TCK) by a Chinese sovereign wealth investor. Teck is among the world’s leading producers of copper, metallurgical coal and zinc. It also has an interest in the Fort Hills oil sands project.

Chinese imports of metallurgical coal could reach 20 million tons this year and could grow significantly in coming years. And Teck’s acquisition of Fording Canadian Coal last year has positioned it as a primary potential supplier, particularly given its access to Westshore Terminal Income Fund’s (TSX: WTE-U, WTSHF) strategically located facilities on the west coast of Canada.

That adds up to more deals ahead. And unlike the oil-rich nations of the Middle East, China has the foreign-exchange reserves to do the job. Reserves actually hit a record in the second quarter of 2009, in large part because China didn’t have to dip into its substantial stock of reserves during the crisis.

The country now holds more than USD2 trillion in foreign exchange reserves. That’s a lot more than it needs to meet day-to-day liquidity requirements. Consequently, it’s essentially a fund for acquisitions, with Canada a primary shopping ground.

Of course, even Canada is vulnerable to xenophobia and protectionist sentiment. Prime Minister Stephen Harper’s government did approve the acquisition of mid-sized Canadian energy producer trust PrimeWest in mid-2007, but not before some opposition was expressed to the Abu Dhabi government buyer.

China’s harsh experiences abroad, however, have increased its sensitivity to such sentiment and the ability of political pressure to thwart its ambitions. That’s clearly evident from the fact that the Teck deal has generated so little controversy, despite being one of Canada’s leading resource producers.

The deal even suggests a formula for getting future deals through. Mainly, the acquiring entity China Investment Corp (CIC) is eschewing board representation and will vote only 7 percent of the shares despite holding a 17 percent.

In addition, the CIC-Teck deal is also likely to improve overall trade relations between the two countries. Two-way investment is emerging as an increasingly central theme for the next chapter in Canada-China relations, as governments try to promote more capital flows, and no area is more primed for investment than oil.

China’s dependence on foreign oil has now surpassed that of the US at 57 percent, according to Scotia Capital. In contrast, China’s import dependency was less than 40 percent in 2003 and averaged 50 percent in 2008. That number will only grow in coming years as the country’s middle class grows and its own resources become ever-more inadequate. In 2008, China sold more cars last year than the US and is forecast to see another 10 percent rise this year.

China Plays

Virtually every Canadian trust and dividend-paying corporation tracked in How They Rate is at least a potential beneficiary of growing Chinese-Canadian trade and investment. As pointed out above, growing trade with the East reduces dependence on US economic cycles. And having more than one major customer for key natural resource exports is critical support for demand and prices.

That’s sure to benefit Canadian oil and gas producers particularly in coming years. In fact, takeovers of trusts are increasingly likely as we approach 2011 taxation.

Direct foreign investment in Canada from any source increases the value of assets across the board. And deals structured along the lines of the Teck purchase can help companies get out of tight spots as well as position for the future.

Investment and trade also increases demand for Canadian dollars globally. That, in turn, benefits investors with higher exchange rates that boost the value of Canadian investments as well as dividends paid in Canadian dollars.

The budding relationship with China has muted the worst effects of the North American recession in Canada. But only as we cycle out of the current slump will the real potential of the relationship unfold for investors.

There are, however, a handful of companies worth highlighting as more direct China bets. One of these is Aggressive Holding Ag Growth International. Even as the market for other agricultural products has slumped, demand for corn handling equipment is strong as ever, thanks to a near record planting. The company’s focus on state-of-the-art techniques like aeration is another plus, particularly with adoption rates soaring.

The faster China develops, the more agricultural products it will have to import. That means bigger plantings and harvests and surging demand for the company’s products, which are also beneficiaries of government mandates for using ethanol.

After converting to a corporation this year without cutting distributions, the company no longer has any 2011 risk and a tremendous amount of upside. Buy Ag Growth International up to USD30.

Labrador Iron Ore Royalty Income Fund (TSX: LIF-U, OTC: LBRYF) is basically a royalty stream on profits from sales of iron ore concentrates and pellets produced at the Iron Ore Company of Canada facility. The IOC plant is operated by global mining giant Rio Tinto Plc (NYSE: RTP), which is also a major player in setting the global price of iron ore contracts each year.

The recession has taken its toll on demand for iron ore, as well as profit margins from product sales. The drop in prices, however, has actually been far less than expectations, largely because of China’s insatiable demand for steel to build infrastructure.

Iron ore is the essential raw material for making steel. A resumption of demand outside Asia, particularly in North America, would almost certainly push prices a lot higher in a hurry. A return to mid-2008 prices would better than double Labrador’s distribution. Buy Labrador Iron Ore Royalty Income Fund up to USD35.

Finally, few companies boast the resource riches of Teck or its ability to export its wares to Asia. The mining giant is still financially weak due to debt taken on at a bad time to pay for the buyout of Fording Canadian Coal.

But the rich reserves it acquired then ensure it will be a major supplier to China, which ironically will also profit from its prosperity due to its ownership stake. Teck Resources is a buy for the more aggressive up to USD25.

Those in search of a less aggressive and higher-yielding bet should look again at Westshore Terminals, whose primary business is terminaling Teck’s metallurgical coal output for export to Asia.

Distributions move up and down with volumes shipped and the price of met coal and have consequently been a bit bumpy over the past year. That won’t change until the global economy turns up. But once it does, this is a low-risk way to play both met coal and the growing Canada-China trade. Buy Westshore Terminals Income Fund up to USD11.