The Global Spread Of Risk Aversion: NZD Heads South

The Speculation Game:

The US sneezes and the world catches a cold: a credit squeeze, sub-prime mortgage woes and fear of what might unfold in the financial derivatives markets has hit the US markets over the last few days. And the ripple effects across the globe swing investors everywhere towards risk aversion and traditional safe havens.

The USD has been a traditional safe haven, but is out of favor at the moment. Don't be surprised if it swings back into favor as the search for safe havens continues, and especially if the focus of economic woes moves offshore - eg: to one of the many developing countries with overheated stock markets.

Two other obvious and traditional safe havens are the Swiss Franc (CHF) and spot Gold (XAUUSD).

Way back in August 2005 I wrote "The Silence Of A Bursting Bubble" which covered the US housing market bubble and the first signs of it bursting. It also covered the flow-on impact on the finance sector. At the end of the article I noted that:

"If the Fed is remarkably fleet-of-foot they may just be able to avoid a nasty recession . but would that just lead to a third bubble this decade? Gold at US$1000 an ounce? No that's NOT a forecast! All I can say for sure is we're in for some interesting times ahead."

If Gold does become a safe haven for investors as they flee from risky derivatives and Hedge Funds, then maybe a push well beyond the last spike to $730 per ounce is on the cards. Back in 2005 when spot Gold was at $430 per ounce a claim of potential for $1000 per ounce seemed outrageous - but now it doesn't feel quite so extreme. Yes, interesting times ahead indeed!

The counter view is that speculation has been driven by easy money, and a credit squeeze will kill off the speculative bug for a long long time. I suspect that's true, eventually, it's just a question of when the bug will die? It's likely that pockets of speculation will continue awhile (Gold, China's stock market - SSEC Index?), but be participated in by fewer and fewer of the worlds investors.

Heard Of The Carry-trade Game?

While on the topic of speculation, here's how the carry-trade game works in the forex market:

Professional currency speculators borrow Japanese Yen (JPY) and pay 2-3% per annum. They then sell those JPY on the forex market and buy NZD (New Zealand Dollars). They make 4-5% on their NZD investment as NZ interest rates are significantly higher than those in Japan.

He pockets the 2-3% rate differential. Meanwhile the combined buying activities of all these carry-trade speculators drives up the NZD (and down the JPY), so he pockets further gains. But if the NZD weakens, that 2-3% margin is quickly lost and our speculator friend is left frantically trying to close out (cover) all his short JPYNZD positions. To do this he buys JPY and sells NZD, which simply adds fuel to the fire and further accelerates the decline of the NZD.

As the flight to safety takes hold globally, activities like forex carry-trades quickly become spurned in favor of traditional safe havens like spot Gold, the Swiss Franc (CHF) - or even the currently unfashionable USD!

NZD Heads South:

Since New Zealand has some of the highest interest rates within the "stable", developed countries, it is a key target for carry trade speculation. If the carry-trade business unwinds rapidly, the NZD will fall against all major currencies. My systems have recently thrown three short signals for the NZDGBP pair, and my signal clients currently have a short NZDGBP position open (as do I). These signals were based on technical analysis considerations, but when you add in the fundamental analysis outlined above, the case for a decline in NZDGBP becomes very strong indeed.

In the last day NZDGBP has declined by 2.5% and nearly 100 points, so the NZD journey south is underway in impressive style.

While 100 points in one day is impressive, the possibility of a 900 point slide is mouth watering! I expect NZDGBP to bottom in the 0.3000 to 0.3100 band - a long way south of the recent 0.3929 peak.

For a trading strategy in this kind of situation, it pays to take a longer-term perspective as this trade could last 5-8 months and be one of those 4-5 great trading opportunities each year.

The complete article, including a technical chart and trading strategy for NZDGBP is available at www.TrendSensor.com/MarketBrief/

DISCLOSURE: Murray Nickel holds a short position in NZDGBP.

Article Source: http://www.articlemonk.com

Murray Nickel is a mathematician, statistician, and professional trader. He offers a free trial of trading signals for market indexes and index ETFs, spot Forex, and spot Gold. He also mentors traders aiming to build consistent success at trading global markets.
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