Monday, February 1, 2010

The Big Mac Index And Foreign Exchange Investment

Steve Sjuggerud believes that conditions in Europe will lead to a fall in the Euro this year. One indicator that the Euro is in trouble is the Big Mac index which suggests the Euro is way overvalued. See the following post from Daily Wealth.

It's time to bet against the euro...

That's the trade I recommended over a month ago in my True Wealth newsletter. And the trade is still as good... no, better... than it was when I first recommended it.

Here's why I recommended it in the first place... and why NOW is an even better time to make the trade than when I told my paid subscribers about it in mid-December...

First, as I'm sure you've already heard, Greece is at risk of falling out of the euro. But we have many other factors telling us the euro will continue to go down...

First off, we have the trend... In currencies in particular, once a trend gets going, it's hard to derail it.

Last year's trend was a crashing dollar. In 2010, it looks like the trend will be a crashing euro. No matter how you analyze trends, you'd have to say the euro is finally in a downtrend right now... It peaked in late November and is down more than 8% already. That's a huge move for such a short time in a major currency.

When I first recommended betting against the euro in mid-December, I wasn't certain we were in a downtrend yet. Now, it's absolutely clear... the euro fell into the $1.30s yesterday for the first time since last summer.

Also, importantly, the euro is WAY overvalued relative to the dollar.

One of my favorite simple indicators of whether a currency is overpriced or underpriced is the "Big Mac Index" from The Economist magazine... As the chart here shows, whenever a Big Mac in Europe is 50% more expensive than a Big Mac in the States, the euro crashes.

We're not at the 50% overvalued point anymore (which is a real extreme). But the euro is still very expensive... A Big Mac in euros is around 35% more expensive than a U.S. Big Mac.

We will also likely have interest rates in favor of the dollar in 2010...

If the European Union must save Greece and the other "PIGS" (Portugal, Italy, Greece, and Spain), then interest rates in Europe will stay low. But the U.S. is in recovery, where rates can rise. At the very least, Europe won't have any interest-rate advantage.

Other factors in the dollar's favor include a potential reversal of the Big Trade of 2009. In 2009, as risk abated, everything went up and the dollar went down. Now, risk is making a bit of a comeback – the dollar (the safe haven) could go up. Another factor is, with the troubles in Europe, the euro has little chance of competing with the dollar as the world's reserve currency.

I could go on... But in short, this type of opportunity doesn't come along often.

The euro is in a horrible situation right now. A mountain of factors is against it. It is overpriced. And in the last two months, a firm downtrend has been established. It is time to bet against the euro.

This post has been republished from Steve Sjuggerud's blog, Daily Wealth.

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