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Why the Big Mac suggests the Aussie dollar is undervalued

Wes Goodman

The cost of a Big Mac is giving Australian dollar forecasters ammunition to predict an end to a three-year rout.

Australia’s currency is undervalued by 30 percent, based on the price of the McDonald’s Corp. hamburger in the nation versus the cost in the U.S. The last time the gauge designed by the Economist magazine was at this level was 2009, and the currency went on to rally 28 percent that year.

A separate measure of purchasing power parity from the Organization for Economic Co-operation and Development shows the Aussie is overvalued by about 1 percent, dropping from 17 percent a year ago.

The three-year selloff was driven by an economic slowdown in China that drove down the prices for Australia’s commodity exports.

Bloomberg surveys of economists show all of that’s going to change in 2016 as growth quickens and the price of iron ore, the nation’s biggest export, picks up.

The decline in the Australian dollar will come to an end, based on the responses.

Also read: Aussie economy gets 'adrenaline shot' from falling dollar

“It’s a brave call given China and commodity prices but this type of analysis is saying, in the long term, it probably looks to be quite good value,” said Roger Bridges, chief global strategist for interest rates and currencies in Sydney at Nikko Asset Management Australia, which oversees $14.6 billion.

“Don’t expect it to move around to give you instant gratification. It just takes time.”

Bridges said his company had been betting against the Aussie and is cutting that position.

Goldman Sachs Asset Management closed a short position in the nation’s currency, the company said in a report Jan. 15. A short is a bet an asset will fall.

Purchasing Power

The Economist magazine developed the Big Mac index in 1986 as a guide to whether currencies are at their “correct” level, according to the publication’s website.

The gauge is based on purchasing-power parity, the idea that exchange rates should move toward the level that would equalise the prices of identical goods in any two countries.

The Aussie has tumbled 5.4 percent this year to 68.92 U.S. cents as of 12:51 p.m. in Sydney. It fell to 68.27 cents on Jan. 15, the lowest level since 2009.

China took investors by surprise this month by pushing its currency down, igniting concern government officials felt compelled to take emergency measures to stem a slowdown in the economy.

As China is Australia’s biggest trading partner, traders took it as reason to push the Aussie lower in tandem.

Samsung Asset Management is one of the companies staying away.

“We don’t have any positions in the Australian market,” said Wontark Doh, head of overseas fixed-income investment in Seoul at South Korea’s biggest private money manager with $113 billion in assets.

Also read: Why the Aussie dollar will move higher

“The Australian market is more affected by the Chinese market. The weakening of the Chinese yuan is persisting.”

Bull Case

Federal Reserve Bank of Richmond President Jeffrey Lacker presented the bull case on China last week by saying the world’s second-largest economy is still growing rapidly, just not extremely rapidly.

In Australia, economic growth will quicken to 2.6 percent in 2016 from 2.3 percent in 2015, based on Bloomberg surveys. The price of iron ore will climb to $46 a ton from about $40 a ton.

The currency will end the year at 69 cents per dollar, based on a separate survey.

“I’m not too bearish,” said Ali Jalai, a bond trader at Bank of Nova Scotia in Singapore. “It seems to me the Australian dollar will stabilize.” The currency may be 70 cents to 72 cents by year-end, he said.