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The Most Overbought Currency in the World

brazilian real

(And How I’m Using it
to Finance My Vacation)

By Evaldo Albuquerque, Editor, Exotic FX Alert

How can you tell if something is overvalued?

If you want to buy a car, a house, a computer and pretty much anything else, it’s pretty simple. You just need to look at what similar products are selling for, and compare prices.

For currencies, there’s also an easy way to see if a currency costs too much.

You just have to glance at the Big Mac Index. With this index, I was able to identify the most overvalued currency in the world.

I’m using this overbought currency to pay for most of my vacation expenses. Let me explain….

Big Macs Cost a Whole Lot More Here

The theory of purchasing power parity says that a dollar should buy the same amount of the same good everywhere.

So at least in theory, a Big Mac should cost the same price in every country. But it doesn’t always work out that way.

At the moment, a Big Mac in the U.S. costs around $4.07. But here in Brazil, where I’m spending some time with my family, Big Macs are more expensive.

After converting your dollars into the Brazilian real, a Big Mac should cost R$6.71 Brazilian reais. (You multiply $4.07 by the current exchange rate of 1.65 to get that.)

But a Big Mac here in Brazil actually costs close to R$10. That’s much more expensive than it should be.

So according to the Big Mac index, the Brazilian real is more than 40% overvalued. That makes the Brazilian real the most overvalued currency in the world.

That’s great news for me – because I’m using it to finance my vacation.

Don’t Buy Shirts or Phones Here

Every time I visit my hometown in Brazil I have to pay for my expenses in Brazilian reais. So I have to convert my income in dollars to the local currency.

I could just buy Brazilian reais at the ongoing exchange rate. Today, that would mean I could get R$1.65 for each dollar.

But thanks to the overvalued Brazilian real, I can do much better than that.

Knowing that the real is extremely overvalued, I decided not to simply exchange my dollars for reais.

Instead, I bought some shirts that cost me $45 in the U.S. each, with the sole intention to sell them here. Based on the ongoing exchange rate of 1.65, that shirt should cost only about R$75 here.

But I’ve been selling those shirts for R$150 to my friends here. Because those same shirts cost R$260 at any local store.

If you used my shirts to value the Brazilian real instead of the Big Mac Index, you would see the real is more than 240% overvalued right now. That’s just ridiculous!

I did the same thing with my cell phone. And that’s how I’m paying for my vacation.

Waiting for the Right Time to Buy the Real

The Big Mac index is a long-term indicator. In other words, currencies can remain overvalued for years.

But my trip is showing me the real is extremely overvalued. So I wouldn’t buy it now. I would consider buying it only after a significant correction.

That’s especially the case now that the Brazilian Central Bank has just started to cut interest rates. This should weaken the currency in the short-term.

Another thing I’ve noticed while I’m here is that Brazil still has a bright future. Like any other nation, it will from time to time face some short-term challenges. But I see signs of great economic strength everywhere I travel.

So I still believe in the Brazilian currency for the long-term. But the price you pay is one of the most important things in any investments, including currencies.

Right now, the real is just too expensive. If you’re interested in buying this currency for the long-term, wait for a correction of at least 20% to buy some.

Best Regards,

Evaldo Albuquerque
Editor, Exotic FX Alert

Source: The Sovereign Investor

How to Make a Killing in the Yen

Japan Is About to Cry “Uncle!”

Make a Killing as Japan
Intervenes in the Yen Once Again

By Sean Hyman, Editor, Currency Cross Trader

Everyone wants to stay competitive.

Target wants to keep their prices somewhat in line with Wal-Mart. Burger King wants to keep their pricing somewhat in line with McDonalds. Otherwise, they lose customers to their competitors.

The same thing happens in the currency world.

All throughout Asia, many countries do tons of business with the U.S. and Europe. These Asian exporters have to keep their pricing somewhat in-line with each other.

Otherwise, their big export customers in Europe and the U.S. will do their shopping elsewhere.

How does a whole country keep their pricing competitive? Easy. They keep their currencies valued about the same.

An Overly Strong Currency
Can Destroy an Economy

If a country doesn’t manage their currency, their major export goods will start looking “expensive” to the rest of the world. If that happens, their best export customers will look elsewhere for cheaper goods.

This wreaks havoc on export countries.

Businesses slow down. Companies lay off workers. Unemployment levels eventually rise. It also slows down that nation’s overall growth.

So there’s a lot riding on these countries to “get it right” and keep their exchanges rates somewhat in-line with one another. Otherwise, they lose business to another exporting country who managed their exchange rates more effectively.

Japan is one of the Asian exporters that occasionally loses its competitive edge in the global market.

It’s all because of the Japanese yen.

The Japanese yen is seen as a “safe haven” currency. So when stock markets drop, or disaster strikes in some part of the world, traders pile into the yen and force it to climb against the dollar. Suddenly Japan loses its competitive advantage.

To make matters worse, Japan is a big export country. Japan has big-name exporters like Toyota, Sony, and Panasonic. Each of these exporters stands to lose billions in business as the yen strengthens in value.

So it’s no surprise that these companies scream at the Bank of Japan to do something when the yen gains in value.

They demand the Bank of Japan (BOJ) “intervene” in the currency market to force the dollar to rise against the yen. They want to push the USD/JPY exchange rate up enough to get the U.S. to buy Japanese goods again.

What Intervention Looks Like

To intervene in the markets, the BOJ must sell the Japanese yen aggressively in the market to try to manipulate the yen’s price.

The Bank of Japan did this back in 2004 for instance. They were very successful in the short-term. Check out the chart below, and you’ll see what a “currency intervention” looks like.

Japan Intervened Twice in 2004!

Click here to view larger image

As USD/JPY goes lower on the chart, it means the dollar is dropping like a rock, while the yen gets even stronger.

So when the central bank intervenes, the Bank of Japan dumps Japanese yen and buys up dollars as quickly as possible. That tends to shoot the USD/JPY higher on the chart, at least in the short-term.

For example, in February 2004, the Bank of Japan intervened in the markets and pushed the dollar up 6.71% against the yen in just 12 days. That’s an unleveraged return.

However, even with a modest 100-to-1 leverage, you could have made over six times your money in the Forex market.

Even without doing the math, you can see Forex traders made a killing in 2004, simply by buying the USD/JPY. (In effect, just following the BOJ’s lead.)

For the Forex traders out there… that was a move of over 700 pips. So if you were trading five mini-lots, you would have made $3,500. Trading 10 mini-lots, you would have made $7,000.

In April of 2004, the central bank dug their heels in and really taught the USD/JPY short sellers another lesson.

They intervened in the market and forced the USD/JPY pair to climb over 1,100 pips or 11.05% in under two months. So if you had bought the pair, you would have potentially made $1,100 per mini lot traded in the Forex market.

Now the Bank of Japan doesn’t intervene in the market very often. In fact, they didn’t intervene again until September 2010. Then they did again in March of this year.

The Bank of Japan is at it Again!

Please click here to view larger image

As you can see from the chart above, the Bank of Japan has intervened twice in the past year. The Bank of Japan intervened by themselves in Sept. 2010 as they typically do.

But in March, earthquakes, tsunami and a nuclear incident made the yen stronger than ever, as traders rushed for the safe haven. That caused many G-7 central banks to join in on the party…and all intervene in the yen at the same time.

That forced a much larger leap in the USD/JPY as you can see above.

The Strong Yen is Back in
the “Intervention Zone” Yet Again

Well, that “stubborn yen” has continued to strengthen yet again. Right now, we’re right in the middle of the intervention zone (the green area), where the Bank of Japan typically intervenes in the currency.

That means it’s very possible the Bank of Japan will intervene again to push up the yen’s value. Now there’s no way to know if they will intervene tomorrow, or next month, or later this year.

But as a trader, I know those Japanese exporters must be crying uncle now. That means I’m watching and listening for any whisper of another intervention.

I know it’s coming. It’s just a matter of when.

They could intervene tomorrow, considering the USD/JPY exchange rate has hit the 78-79s (as of this writing). Or they may wait until the USD/JPY hits the 76 level like last time. Or they could even wait for a new all-time low before they act.

But honestly, I don’t care when they intervene. It’s more of a question of reacting when they do.

Once you hear about an intervention happening, there are some serious profits to be made, simply by buying the USD/JPY pair in the Forex market.

And as a long-term investor, you can short the yen in the short-term with a simple ETF.  Again, it’s as easy as shorting the yen at the proper time.

Bottom line: an intervention is coming soon. When it comes, you can make a killing simply by following the Bank of Japan’s lead and shorting the yen.

Have a Nice Day!

Sean Hyman
Editor, Currency Cross Trader

3 Currencies to Buy as Trichet Loses His Nerve

By Evaldo Albuquerque, Editor, Exotic FX Alert

Central bankers are some of the worst magicians in the world. Unfortunately, they love to use their sleight of hand on our monetary system.

As we saw last week, one of their favorite tricks is to make bad debt disappear.

Remember when all those mortgage securities went bad a couple of years ago? Then the Fed stepped in and waved its magic wand.

A little accounting magic and poof! These toxic mortgage securities disappeared.

But we all know that debt hasn’t really disappeared. It’s sitting right on the Fed’s balance sheet. Nothing has changed. It’s still debt that nobody is addressing.

In the end it’s just a bad magic trick that we all pay for in the long run.

I’m sorry to report the European Central Bank (ECB) is now trying its own hand at making debt disappear.

The good news is this is creating some intriguing opportunities in the currency market. I’ll tell you about them in just a minute. First let’s take a look at the latest magic trick in Europe…

How the ECB is Flushing its Credibility
Down the Toilet

In 1991, Trichet, now the chairman of the ECB, co-wrote the Maastricht treaty that created the EU currency bloc. This means Trichet personally helped write the rules that govern the European Union.

Now he’s throwing that rulebook away.

The treaty prohibits bailouts or any other form of monetary financing of member states. But so far, the ECB has helped bailout Greece, Portugal and Ireland. And the ECB has bought bonds to help finance the broke countries.

Last week, the bank went one step further in breaking its own rules.

Like any central bank, the ECB often gives loans to European banks. When it does, the ECB often takes bonds from debt-ridden countries as collateral. To avoid taking too much risk, the ECB used to require those bonds to have a good credit rating.

But last year the ECB made an exception for Greece. And now it’s doing the same for Portugal.

Last week, the rating agency Moody’s downgraded Portugal’s debt to junk status. Afterwards, the ECB decided to make a change.

Trichet announced the central bank will suspend its minimum credit-rating threshold on Portuguese bonds as well. In other words, the ECB is now prepared to hold more assets that may turn out to be very toxic.

Another Flip-Flop in the Making

Negotiations on how to solve the Greek crisis are still ongoing. At this point, the most probable scenario is that private investors will have to roll over Greek debt. Rating agencies have warned they will treat that as a “selective default.”

The ECB remains opposed to accepting Greek debt if such a “selective default” happens.

Trichet has said many times that the ECB would reject bonds with default ratings as collateral for loans. If he keeps his word, Greek banks will collapse without the liquidity provided by the ECB.

But we all know how much Trichet’s word is worth: not much.

Last year, Trichet said the purchase of government bonds was not an option. Four days later, the ECB started to buy bonds from Greece.

So it’s very likely the ECB will continue to accumulate bonds, even if they have a default rating. The ECB will not pull the plug on the Greek banking system.

And that’s a dangerous game. London- based Fathom Financial Consulting estimates a 70% write-down in Greek debt would cost the ECB about 25 billion euros. Its collateral would take a hit of 20 billion euros.

That’s enough to erase the ECB’s entire capital base.

In other words, when the inevitable Greek default finally comes, the ECB will have so much exposure to these toxic bonds that there is a real chance of it going insolvent.

And let’s not forget that the ECB also holds bonds from Portugal and Ireland.

What Does it All Mean to You?

Even if you don’t live in the EU, this has major implications for the currency markets.

Now does this mean the euro is finished? Not really. Remember, the Forex market is a relative game. So it really depends what you measure the euro against.

In the past year, for example, the euro appreciated 13% against the dollar. But it lost 10% against the Swiss franc, and nearly 4% against the Norwegian krone.

With the European debt crisis going on, a lot of people don’t understand why the euro can be so strong against the dollar. But to understand why that is, you just have to look at the last three words of the previous sentence.

It’s only strong against the dollar.

As an investor, this gives you the opportunity to buy the currencies that are beating out both the dollar and the euro, like the Swiss franc and Norwegian kroner.

Also, the fact the ECB is losing credibility is very good news for another currency: gold. It has gone up almost 15% against the euro over the past year.

Gold has also been pretty stable lately, despite the correction in other commodities. It just shows how the yellow metal is behaving much more like a currency than just a commodity.

As this euro mess plays out, gold will be yet another currency in the best place to profit – particularly if the ECB runs out of cash on its books.

Bottom line: the ECB will do whatever it takes to avoid a major crisis, even if it has to hold toxic bonds that may turn out to be worth as much as toilet paper. For you, this is a great opportunity to load up on gold and other sounder currencies, such as the Swiss franc and Norwegian Krone.

Best Regards,

Evaldo Albuquerque
Editor, Exotic FX Alert

Source: The Sovereign Investor

Why March 25th Will Seal the Euro’s Fate


By Evaldo Albuquerque, editor, Exotic FX Alert

Imagine getting a letter from your bank saying your mortgage bills will double starting next month.

If you were paying $1,200 a month, you’re now responsible for a $2,400 payment. And there’s nothing you can do about it.

It’s not far-fetched. It already happened to thousands of Americans, just a few years ago.

During the real estate boom, adjustable-rate loan companies suckered in Americans with their very low teaser rates.

House prices back then were so high that many people could only afford to buy a home with this kind of loan. The initial low rates made the monthly payments very affordable.

But things got very ugly once those loans reset to higher rates. Mortgages bills skyrocketed, and forced many Americans to give up their homes through foreclosure.

Now, something very similar is happening in Europe. But it’s not happening in the housing sector.

This time, governments are the ones facing skyrocketing interest payments. And there’s one more EU country that’s doomed to face a “rate reset.”

When it does, it will send the euro spiraling even lower. Let me explain…

Why 7 Is the Point of No Return for the EU

Recent events have proven that the European troubled nations (affectionately known as the “PIIGS”) can’t handle interest rates above 7%.

What that means is, these nations can’t afford to pay bond rates above 7%. When the yields on 10-year sovereign bonds cross that level, it’s nearly certain that a country will ask for a bailout.

In other words, when bond rates hit 7%, these countries cry “uncle!”

That number has already exposed the true extent of Greece’s and Ireland’s problems. Once Greece’s debt holders started demanding an interest rate above 7%, it took Greece 16 days to ask for a bailout. Ireland requested a bailout 20 days after Irish debt hit the magic 7% level.

Those countries just couldn’t afford such high borrowing costs. It’s just like what happened during the U.S. real estate crisis – only on a grander scale. Eventually, the mortgages rise to a rate that Americans simply can’t afford to pay – and they foreclose.

Well in sovereign debt, nations ask for a bailout once their debt hits 7% rather than “foreclose.”

And now, the dreaded 7% interest rate is about to make another victim: Portugal.

It has just breached that important threshold. Check out the chart below. It shows the yield on 10 years bonds from troubled European nations.

Portugal Can’t Afford Such High Borrowing Costs

Portugal: The Next Shoe to Drop

Portugal’s borrowing cost is approaching dangerous levels. Some European Union member states are increasingly concerned about Portugal’s ability to fund itself in financial markets. With interest rates on the rise, Portugal is not going to be able to hold on beyond the end of March.

Meanwhile, investors are demanding a higher interest payment on Portugal’s bonds because of uncertainty regarding the rescue fund.

European authorities promised to announce a comprehensive plan to solve the debt crisis by March. But there are a lot of disagreements between Germany and troubled nations, such as Greece and Italy.

Germany is proposing tougher austerity measures in exchange for beefing up the rescue fund. But Greece and Italy have already rejected Germany’s proposal.

So there’s a good chance European authorities won’t keep their promise of delivering a final solution by the end of next month. When that happens, Portugal will be in trouble.

Mark This Date on Your Calendar

Athanasios Orphanides, one of the European Central Bank members, has recently warned that without a comprehensive plan, European nations might slip back into crisis.

In his opinion, the longer political leaders “delay in agreeing on a framework that will ensure stability, the greater the threat of another crisis similar to what happened in 2010.”

All the European Union nations will be meeting at a summit at the end of next month. March 25 is the informal deadline for the leaders to announce a comprehensive package of measures to address the sovereign debt crisis in Europe. If they fail to announce anything significant, the market will get very upset.

Orphanides’ fears will become reality, and the euro will take a dive. So make sure you mark this date on your calendar.

In the meantime, I’m shorting the euro with everything I’ve got. I recommend you do the same.

Best Regards,

Evaldo Albuquerque
Editor, Exotic FX Alert