WaysToPlay the BIG Mac Index

Source: The Economist

The Economist is out with an update to their famous Big Mac index.  For those of you unfamiliar with the index, it is based on PPP (purchasing-power parity), suggesting that foreign exchange rates should equalize the price of a basket of goods across different countries.  The Economist tracks the price of a Big Mac in various countries against its price in dollars, suggesting an over or under-valued relationship with the dollar.

According to the Big Mac index, The Chinese Yuan is significantly undervalued, about 50% below its fair-value with the dollar.  Conversely, the Norwegian Krone is overvalued, about 90% over its fair-value with the dollar.

Following the current index, the “Ways To Play” the Big Mac ETF trade is (note: not all currencies on the Big mac list have ETFs):

Long Undervalued Currencies:

Chinese Yuan (CYB)

Russian Ruble (XRU)

South African Rand (SZR)

Mexican Peso (FXM)

British Pound (FXB)

Short Overvalued Currencies:

Swiss Franc (FXF)

Euro (FXE) or (long ultrashort EUO)

Canadian Dollar (FXC)

Australian Dollar (FXA)

The question is of course, how good of an indicator is the Big Mac index in currency returns? We’ve tracked the last two editions of the Big Mac index using currency ETFs, and this is what we’ve discovered:

The index in July 2009 was suggesting that the Yuan, Mexican Peso and South African Rand were undervalued, while the Swedish Krona, Swiss Franc, and Euro were overvalued:

Using equal parts of each Currency ETF (shorting overvalued, long undervalued) the Big Mac Trade is up 0.75% since July 21st.

Undervalued Currencies:

Chinese Yuan (CYB)  -0.83%

South African Rand (SZR) +4.87%

Mexican Peso (FXM) +6.15%

Source: ETFDesk.com

Overvalued Currencies:

Euro (FXE) -3.17%

Swedish Krona (FXS) +7.84%

Swiss Franc (FXF) +1.05%

Source: ETFDesk.com

The Economist updated Big Mac index in early January 2010, suggesting the Chinese Yuan, Russian Ruble, Souther African Rand, and Mexican Peso were undervalued, while the Euro, Swiss Franc, and Australian Dollar were overvalued.

The Big Mac ETF trade is up 3.64% since January 6th.

Individual ETF Returns since January 6, 2010

Undervalued Currencies:

Chinese Yuan (CYB) -0.20%

Russian Ruble (XRU) +2.43%

Mexican Peso (FXM) +1.59%

South African Rand (SZR) +0.25%

source: ETFDesk.com

Overvalued Currencies

Swiss Franc (FXF) -2.56%

Australian Dollar (FXA) -0.07%

Euro (FXE) -4.46%

Source: ETFDesk.com
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