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Risk Aversion Ripples Across the Globe: NZD Heads South

By: Murray Nickel

The Speculation Game:



Sub-prime mortgage woes and fear of flow-on effects in the financial derivatives markets in the US sends investors globally on a flight to traditional safe havens and away from speculative markets.



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.



Right now, however, there are two more obvious safe havens: the Swiss Franc (CHF) and spot Gold (XAUUSD).



It's a long time ago that I wrote an article about the impending slide in the US housing market. In fact it was August 2005 that I penned "The Silence Of A Bursting Bubble". At the end of that article I wrote:



"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.



The Carry-trade Game:



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



A Japan-based currency trader borrows Yen at 2-3% per annum, sells the Yen (JPY) on the forex market and buys New Zealand Dollars (NZD). He earns 4-5% on his NZD holdings as interest rates in NZ are higher than those in Japan.



They bank the 2-3% rate differential. Meanwhile the buying of NZD by all these carry-trade speculators drives up the NZD (and down the JPY), so they bank further gains. But if the NZD weakens, that 2-3% margin is quickly lost and our speculator friends are left frantically trying to cover all their short JPYNZD positions. To do this they buy JPY and sell NZD. This simply adds fuel to the fire and further accelerates the demise 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.



Less than 24 hours later and NZDGBP has declined by 2.5% and nearly 100 points, so the NZD journey south has begun in earnest.



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: Free Content Articles Directory

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 succeed at trading global markets.

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