Profiting from the Coming Collapse of the Euro

This week’s Global Bull Market Alert pick — the Market Vectors Double Short Euro ETN (DRR) — is a bet that after six years of relentless decline against the euro, the dollar’s fortunes are finally shifting, and that it’s the euro that is set for a mighty tumble. And here’s why.

The Economist magazine recently published its annual “Big Mac Index” — a tongue and cheek measure of “purchasing power parity“ (PPP) — that is, the relative over and undervaluation of the world’s currencies. Based on that measure, the euro is among the most overvalued currencies on the planet. Today, a Big Mac costs 50% more in euros than it does in U.S. dollars. The euro never has been this overvalued in its short history.

That’s not to say that the dollar will be gaining on the euro based on newfound optimism about the U.S. economy. Instead, the euro’s move downward has been sparked by the growing realization that large parts of Europe are in recession. Comments last Thursday from Jean-Claude Trichet, president of the European Central Bank, warned that the eurozone economy would weaken substantially in the coming months.

Just this past Friday, the euro also broke out of a long-standing trading range to the downside, as the dollar rose 2% to a five-month high against the euro. Liquidity, combined with short covering of long-terms bets against the dollar, means that this August the chances of further large moves against the euro during the coming days are high.

The U.S. dollar also tends to move in six- to seven-year cycles, shifting between periods of extreme undervaluation to overvaluation. In 2002, it was the greenback that was as overvalued as it had ever been in the then 15-year history of the Big Mac Index. So after six years of relentless decline, the dollar is due for a strong bounce back.

As Marc Chandler, global head of foreign exchange at Brown Brothers Harriman, optimistically put it: "The U.S. (dollar’s) multiyear downtrend is over." To profit from the dollar’s recovery against the euro, buy the Market Vectors Double Short Euro ETN (DRR) and set your stop at $37.50. This ETN replicates a special Double Short Euro Index. As the index is two-times leveraged, for every 1% weakening of the euro relative to the U.S. dollar, the level of the index will generally increase by 2%. For every 1% strengthening of the euro relative to the U.S. dollar, the index will generally decrease by 2%. So, if the euro declines 10% from its current level of $1.50 to the U.S. dollar to, say, $1.35, you can expect to lock in a gain of twice that with this ETN. That gain would be about 20%.

PORTFOLIO UPDATE

The WisdomTree India Earnings ETF (EPI) continues to power ahead, and is re-establishing a firm uptrend, even as the local market closed up more than 2% in overnight trading. EPI is up 12.18% during the past two weeks, and the options are up 76.67%. Hold on to both for now and tighten your stop to $17.60.

You were stopped out of oil driller Atwood Oceanics (ATW) for a loss as the oil and commodities picks in your Global Bull Market Alert portfolio are suffering from the sudden shift in market sentiment against commodities-related stocks.

With the strengthening of the U.S. dollar, we stopped out of the CurrencyShares Japanese Yen Trust (FXY) Friday at a slight loss.