Canada is perpetually underrated and understated in the eyes of its giant neighbor to the south. Despite sharing a long border, many cultural similarities and the world's largest bilateral trade relationship between two countries, many Americans still think of Canada simply as the land of cold weather, ice hockey and Mounties in red tunics.

And as an investing destination, Canada is similarly beneath the radar. Some see it as too close and too similar to the U.S. to be a "real" international investment. Indeed, the close geographic and trade ties elicit the joke that when the U.S. sneezes, Canada catches a cold. Others peg it as merely a giant commodity play thanks to its vast oil reserves, wheat fields, mines and other natural resources.

Neither perception is entirely accurate, although the commodity angle certainly has some merit. "Canada is about resources," says Brian Wruk, president of Transition Financial Advisors Group in Gilbert, Ariz., a firm that specializes in advising expatriates on both sides of the U.S.-Canadian border. "The Canadian government has struggled for years to diversify the economy. But it's still about potash, oil, gold and uranium."

Increasingly, it's about financials as well. Canada has been scoring points for a smart financial sector that avoided many of the egregious mistakes of the U.S. financial system and weathered the recent global economic downturn in much better shape. In fact, the World Economic Forum in the past two years named Canada's banking system as the world's soundest.

Last year that organization also ranked Canada ninth in its most recent global competitiveness report, up from tenth the previous year and 13th the year before that. Perhaps the easiest way to invest in Canada is through the iShares MSCI Canada Index fund (EWC), an exchange-traded fund and the largest Canada-focused fund of any sort. That's what Wruk does for his clients.

"You invest in Canada for a commodity bet and a currency exchange play," Wruk says. The thinking is that one can profit from a fall in the U.S. dollar--a likely scenario given the tons of money printed by Uncle Sam during the past year--by investing in a commodity-rich economy such as Canada's. As the U.S. dollar falls and commodity prices rise, that should bolster the Canadian dollar, otherwise known as the loonie.

But Canada also offers opportunities for stock pickers--and income investors--willing to probe a little deeper into its economy.

Beyond The Big Three
According to the iShares Canada ETF, this is what Canada's investable economy looks like: financials (37%), energy (26%) and materials (20%), plus a smattering of other sectors. At least that was the fund's sector breakdown as of November 30. Its top ten holdings included three banks (Royal Bank of Canada, Toronto-Dominion Bank and Bank of Nova Scotia), three oil and gas companies (Suncor Energy, Encana and Canadian Natural Resources), two gold miners (Barrick Gold and Goldcorp) and fertilizer maker Potash Corp. of Saskatchewan. The oddball in the group was BlackBerry maker Research in Motion.

"The seeming imbalance in the Canadian market refers to the equity market and doesn't accurately gauge the breakdown of the underlying Canadian economy," says Garey Aitken, chief investment officer at Bissett Investment Management in Calgary, Alberta. He adds that the primary bogey for Canadian equities--the S&P/TSX Composite index comprising the largest companies on the Toronto Stock Exchange--at any given point holds between 75% to 80% of financials, energy and materials, which is mainly commodities.

Aitken says one reason for the equity market imbalance is that the Big Three sectors tend to be publicly traded whereas, say, Canada's huge agricultural sector tends to be privately held. He notes that Canada still has a meaningful industrial base, particularly in southern Ontario and Québec. "There tends to be reliance on natural resources in the west and on industrial and manufacturing in the east."

Aitken says some of the better opportunities are found in sectors outside of the Big Three. In industrials, for example, one of the companies he likes is CN Railway, Canada's largest freight railroad and operators of one of North America's six big railroad networks.

Elsewhere, Aitken likes telecom giant Rogers Communications, a Toronto-based company that operates in the wireless, cable and media segments. In consumer staples, one of his favorite companies is Alimentation Couche-Tard, Canada's largest convenience store retailer and the continent's second-largest independent convenience store operator. Based in the Montréal suburb of Laval, the company made a big splash in the U.S. with its 2003 purchase of the Circle K convenience store chain from Conoco-Phillips.

O Canada
Canada is the world's second-largest country by size, yet its population is only 33 million, or about 3 million less than California. Taking the California analogy one step further, the Yukon Territory in northwest Canada is roughly the size of California but has only about 30,000 people.

Canada's sparsely populated Arctic north is inhabited mainly by native peoples, whales and polar bears. The country's population on the whole hugs the long 49th parallel--which forms much of the border between Canada and the U.S.-as if it were a space heater: One commonly referenced estimate is that 90% of Canada lives within 100 miles (or 200 miles, depending on the source) of the U.S. border.

For American investors, Canada stands out as one of the few resource-rich nations--Australia also comes to mind-that also is politically and socially stable. That said, it's not without its drama. For starters, there's the on-again, off-again threat of Québec secession from English-speaking Canada (currently off).

And in December 2008, shortly after Prime Minister Stephen Harper's Conservative party formed its second minority government since his initial election in 2006, he suspended Parliament for nearly two months to forestall a no-confidence vote many expected him to lose.

Harper did it again last December when he suspended Parliament until after the Vancouver Olympics. His rationale: The government needs time to formulate a new economic plan. His critics' response: Harper is shutting down democracy in Canada.

But there isn't fear of a government meltdown, nor any worries from investors that the government will attempt to nationalize its resource-based economy à la Russia or Venezuela. Despite the hiccups, the country is governed by a consistent rule of law.

From the Atlantic Canada fisheries to the factories in Québec and Ontario, and from the Canadian prairie wheat fields to the tall timber of British Columbia, Canada's economic growth is fueled by exports. The country is a major exporter of nickel, uranium, fertilizer and food. And it's the largest supplier of foreign oil to the U.S.

Canada's close trading ties to the U.S. aside, its export machine to the overall global economy is one reason why the Canadian downturn wasn't as steep as in the U.S. The government recently has ratcheted up efforts to broaden its economic ties to China to help diversify the country away from its traditional reliance on the U.S. For example, in December the government approved Petro-China's $1.9 billion stake in a pair of projects in the oil sands region of Alberta.

According to a report from Royal Bank of Canada (RBC), the Canadian economy emerged from the recession in the third quarter when it grew at a 0.4% annualized rate. RBC expects GDP growth of 2.65% in 2010 and 3.9% in 2011. But the bank worries that the stronger Canadian currency (the Canadian dollar recently traded at 96 cents to the U.S. dollar) could dampen demand for Canadian exports.

According to the report, RBC foresees some downward pressure on the U.S. dollar, "which argues for Canada's dollar drift toward parity, especially as commodity prices continue to rise with the global recovery gaining steam and Canada's recovery builds momentum."

The Rydex CurrencyShares Canadian Dollar Trust (FXC) ETF tracks the price of the Canadian dollar.

Oil Trust
When you think Canadian oil, most people think of the oil sands, or tar sands region of northern Alberta. This isn't the stuff of black gold gushing forth after a shotgun blast from Jed Clampett. Tar sands oil is a gunky mess imbedded in a mix of crude bitumen, sand, clay and water that's essentially surface mined rather than drilled. Mining and processing tar sands oil is a dirty, environmentally unfriendly process.

But thanks to the oil sands, Canada has the second-largest estimated recoverable oil reserves in the world after Saudi Arabia. And thanks to improving technology and high oil prices, exploration in the oil sands region is now economically feasible--at least for some companies.

"For companies like Syncrude and Suncor that have been in the oil sands for more than 35 years and all of their infrastructure and costs are already in and they're making oil, we believe these guys need $40 oil to break even," says Russell Lucas, principal at Lucas Capital Management, a registered investment advisor in Red Bank, N.J., that runs energy-focused hedge funds and private equity funds. "We hear the new guys just finishing or starting their operations up there need more like $80 to $100."

Lucas is a big holder of Syncrude's publicly traded security, Canadian Oil Sands Trust, but his firm has long been more focused on Canadian royalty trusts rather than traditional oil companies. Royalty trusts are publicly traded entities that make profits from producing oil, gas or other natural resources. Their profits aren't taxed at the corporate level as long as the trusts pass through a significant percentage of cash flow as distributions to shareholders, or trust holders.

Canadian royalty trusts, or Canroys, differ from U.S. royalty trusts in that the latter are passively managed entities overseen by banks that don't actually dig or drill, but instead own the mineral rights to mines and wells and depend on others to extract the resources from the ground. Canroys, on the other hand, are actively managed businesses that can buy other properties, raise and borrow money, and manage their own resources.

Canroys have typically paid dividends in the 8% to 14% range, and last March during the depth of the market crash they dished out dividends in the 18% area. But beware of the notorious "Halloween Massacre." On October 31, 2006, the Canadian government announced that Canadian trusts would be taxed at the regular corporate rate of 31.5% as of 2011.

The reason for the killjoy on Canroys: The government said the trusts were costing the federal government about $500 million annually in lost revenue. Lucas says the law change caused trust holders to lose roughly $20 billion in investment value in one day.

"I think a lot of investors are shying away from buying the trusts today," Lucas says. "So I think they're trading at a slight discount to where they'll be after the conversions."

Most royalty trusts eschew the oil sands region in favor of older, more mature oil patches that are less cost-intensive and where new technologies can help increase recovery rates from areas that already have known hydrocarbons. Lucas expects most of them to convert to traditional corporate structures by 2011. Other options include sellout transactions to private capital or foreign investors.

"These trusts are well-capitalized and have growth opportunities with new technologies," Lucas says. "And they'll still pay distributions in the 5% to 7% range. It's been our experience over 40 years that you do better with the old, boring stuff [i.e., royalty trusts plying mature fields] as long as you get a distribution today, rather than just a promise to make money in the future. It's been a tortoise-and-hare situation."

The Claymore/SWM Canadian Energy Income Index ETF (ENY) tracks an index made up of Canroys and oil sands producers.

With the Winter Olympics set to start on February 12, the notion of going for gold applies to both athletes and investors. From an investment standpoint, even if Canada can't shake its reputation as natural resources and nothing but, it still could be the ticket to a winning play on the rebounding global economy.