A Consensus To Bet Against

There's a landmark McDonald's restaurant just off Piccadilly Circus in central London.

My friends and I used it as a meeting place. One time – it must have been about 12 years ago – I remember meeting a school friend there who'd just gotten back from a summer vacation in Tokyo.

As we stood in line, my friend said he'd paid $10 for a Big Mac meal in Tokyo. I have since verified his claim: In 1995, a Big Mac meal cost 750 yen, and the exchange rate was 85 yen to the dollar.

I was aghast. I couldn’t believe a place could be so expensive. Not only did that statement etch itself into my memory forever, I also vowed I’d never go to Tokyo...

An article I found in The New York Times from 1994 confirms the sentiment:

The falling dollar and rising yen makes [Tokyo], known for $5 cups of coffee and $100 muskmelons, even more outrageously expensive for someone who thinks in terms of dollars.
"I'm not going to buy as much," said Rochelle Levy, who is from Des Moines. "We're just walking the Ginza at night hoping the stores are closed, just to see."
Today, the situation has completely reversed, and Japan is the country with the weak exchange rate.

According to The Economist's latest Big Mac index, you'll pay more for a Big Mac in places like Argentina, Costa Rica, Mexico, Singapore, Taiwan, and Pakistan than you will in Tokyo. Right now, Big Macs in Tokyo are even cheaper than they are here in the States... by about 30%.

Currencies tend to move in cycles. This chart of the yen vs. British pound exchange rate is a good example...

The trick to speculating on currencies is being able to identify the tops and bottoms of these cycles. In my experience, sentiment is the best measure. When the sentiment becomes one-sided, that is almost always a good sign the exchange rate is near an apex and about to reverse direction.

Right now, traders are betting more money against the yen than ever before. On January 23, the IMM commitments of traders hit their largest-ever short position. And according to a recent poll of currency analysts by Bloomberg, the ratio of negative recommendations to positive recommendations for the yen hasn't been this lopsided since 2003. 

My favorite currency trading newsletter, John Percival's Currency Bulletin, says that even the diehard "dollar demise" crowd have thrown in the towel and will no longer buy the yen.

"Bearishness of yen has become the number-one certainty of the currency markets," Percival wrote earlier this month. "So yes, we have a consensus there. When carry trades get too crowded and too leveraged, the risk of meltdown gets high. Let's just say it's clear this is the case right now."

Japanese Big Macs are among the cheapest in the world, and everyone thinks the yen has to keep falling... It's probably time to buy.

John Percival's Currency Bulletin is a bit hard to follow for novice investors, but if you're interested in following sentiment flows in the global currency markets, I highly recommend it. His book, The Way of The Dollar, is also an excellent read.