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Jan. 30, 2015, 12:53 p.m. EST

How to make money from the "Big Mac" index

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About Nicholas A. Vardy, CFA

Nicholas A. Vardy is Chief Investment Officer at Global Guru Capital, a fee-only, SEC-registered investment-advisory firm where he manages money for high-net-worth clients. Vardy is also the editor of three investing and trading services at NicholasVardy.com. He appears regularly on the Fox Business Network and CNBC Asia, and is a highly-rated speaker at investment conferences around the globe.

Nicholas regularly contributes his market views on his company blog. You can also follow Nicholas on Twitter @NickVardy or email him at nvardy@globalgurucapital.com.

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By Nicholas A. Vardy, CFA

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Few overvalued currencies

Not surprisingly, the Swiss franc is the most overvalued currency in the world — though at 57.5% overvalued, it's just 3% higher than last year.

As a group, the Scandinavian currencies have always occupied the top of the charts. A Big Mac in Norway today is 31.5% more expensive than in the United States. But that is down from 68.6% more last year. Sweden and Denmark come in this year at a mere 2.7% and 12.2% undervalued, respectively. Once again, this is a far cry from the 36% and 12% overvalued levels, respectively, you saw last year at this time in the currencies for each of those countries.

Brazil's currency — the real — rounds out the ranks of overvalued currencies. Four years ago, the Brazilian real was 52% overvalued on the Big Mac Index. Today, the real is 8.7% overvalued compared to the U.S. dollar.

A slew of undervalued currencies

I've already touched on the dramatic drop in the euro and the yen.

But perhaps the biggest changes in the past year have been the widespread devaluation in emerging-markets' currencies. For most of the past decade, the Chinese Yuan has been the most undervalued currency in the world. Today, it trades 42.2% below its PPP rate, pretty much where it has stood for many years.

Yet, a whole slew of emerging markets' currencies are now cheaper than the Chinese yuan, as competitive devaluations spread across the global economy. Russia, India, Hong Kong, Indonesia, South Africa and India are all top emerging markets that are more undervalued than the Yuan.

What you would trade today

So, if you were running a currency hedge fund and using the principle of buying undervalued currencies — and selling the overvalued ones — here is what you'd do.

Among the "big six" currencies favored by foreign-exchange traders, you'd sell the Swiss franc /zigman2/quotes/202079537/composite FXF -0.34%  — the only major currency that is massively overvalued. You'd ignore the British pound sterling /zigman2/quotes/205988498/composite FXB -0.12%   and the Canadian dollar /zigman2/quotes/202089315/composite FXC -0.18%  , both of which are roughly within 10% of their PPP values. The euro /zigman2/quotes/208198139/composite FXE -0.34%  and the Japanese yen /zigman2/quotes/200725153/composite FXY -0.08%  would be long bets based on their current undervaluation of 11% and 34.4%, respectively . But with both the European Central Bank and the Bank of Japan committed to driving the euro and yen down further, you'd have to be a real contrarian to bet on the European and Japanese currencies.

Looking at less mainstream currencies, you'd buy the Chinese Yuan /zigman2/quotes/203125516/composite CYB +0.04%  (42.2% undervalued), the South African rand (SZR) (53.6% undervalued), the Mexican peso (FXM) (30.1% undervalued) and the Indian Rupee   (60.6% undervalued).

My top recommendation to my subscribers is to continue betting on the greenback's rise against the broad U.S. Dollar Index through the PowerShares DB US Dollar Bullish ETF /zigman2/quotes/209727862/composite UUP +0.22% .

After all, the U.S. Dollar Index is only back to where it was in March 2009, right when global stock markets bottomed.

But that also means the U.S. dollar is still 25% below its 2001 peak — and 50% below its peak in the 1980s.

Fashionable predictions about the "demise of the dollar" notwithstanding, the Greenback has a way to go.

US : U.S.: NYSE Arca
$ 91.98
-0.32 -0.34%
Volume: 13,520
May 20, 2022 4:10p
US : U.S.: NYSE Arca
$ 120.00
-0.15 -0.12%
Volume: 7,746
May 20, 2022 4:10p
US : U.S.: NYSE Arca
$ 76.22
-0.14 -0.18%
Volume: 31,334
May 20, 2022 4:10p
US : U.S.: NYSE Arca
$ 97.75
-0.33 -0.34%
Volume: 116,997
May 20, 2022 4:10p
US : U.S.: NYSE Arca
$ 73.25
-0.06 -0.08%
Volume: 56,334
May 20, 2022 3:59p
US : U.S.: NYSE Arca
$ 25.69
+0.0090 +0.04%
Volume: 4,483
May 20, 2022 4:10p
US : U.S.: NYSE Arca
$ 27.54
+0.06 +0.22%
Volume: 2.68M
May 20, 2022 4:00p

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