Risk Aversion Ripples Across the Globe: 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 in my article "The Silence Of A Bursting Bubble" I covered the impending slide in the US housing market, and the flow-on impact on the finance sector - see also "Is Banking Tanking?" from early December 2006. At the end of the August 2005 article I noted that if the Fed was fleet-of-foot in managing a recession, then the "speculative bug" might move on from housing into spot Gold and cause the 3rd bubble in a decade (after technology and housing):

"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."

At the time I wrote that article in 2005 Gold was around $430 per ounce. It eventually spiked to $730 per ounce and if I'm right about it becoming a safe haven for investors, maybe $1000 per ounce isn't far-fetched after all? Yes, interesting times ahead indeed!

Of course, speculation is fueled by easy money, and a credit squeeze could kill off the speculative fervor for a long, long time. Well EVENTUALLY it probably will. But pockets of speculation should continue for a while yet - perhaps they'll be participated in by less and less of the worlds investors. Chinas stock market and spot Gold are two examples where speculation may continue and bubbles may form, but participation will be much narrower than in the technology or housing bubbles.

The Carry-trade Game:

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

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.

They pocket the 2-3% rate differential, and their NZD buying activity drives up the NZD and down the JPY - so they pocket further gains. This all works well so long as the NZD is rising, or stable vs the JPY, but if it weakens it soon wipes away that 2-3% rate margin and these speculators are forced to cover their short JPYNZD positions: ie they buy JPY and sell NZD to close out their positions.

When global markets move towards risk aversion, the speculative arenas like carry-trades are abandoned in favor of safe havens like Gold, Swiss Francs or (traditionally) the USD.

Carry-trade Casualty: NZD

Anticipating this move to safe havens added to the technical picture and short signals I had received recently for NZDGBP. When reviewing the NZDGBP chart yesterday, I came up with six technical reasons why NZDGBP should decline soon, as per the recent short signals my signal clients have received. Add in the fundamental picture above re the flight to safety, and it was a pretty convincing argument.

In the last 24 hours NZDGBP has declined by nearly 100 points (2.5%), so the NZD slide south has begun in impressive fashion.

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.

This trade could last over five months and be one of those rare money-making trading opportunities that unfold 4-5 times a year and form the foundation of the long-term forex traders success. So it can pay to take a long-term perspective and give the market room to move as it zig-zags down. The alternative is to conduct a series of trades throughout the journey south. This can reduce trading risk, but may increase the risk of losing sight of the bigger picture during the perturbations encountered during the journey.

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

DISCLOSURE: I hold a short position in NZDGBP.

Article Source: http://mylilpeanut.com

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