Risk Aversion Ripples Across the Globe: NZD Heads South
Speculative Games:
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.
Often in the past, when investors have fled to traditional safe havens, the USD has benefited. Of course in this case it's the US economy that appears to be verging on the brink of a recession, so one could argue that a flight to the USD may not unfold. Maybe not, but then again, maybe yes: old habits die hard and if the BRICs block (Brazil, Russia, India and China) stock markets start to get the speed wobbles, trusty old USD may re-emerge as a haven.
But there are two more obvious safe havens: 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."
Back then in 2005 Gold was at $430 an ounce - it's since been to $730, so maybe $1000 isn't so unobtainable 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.
Heard Of The Carry-trade Game?
While on the topic of speculative games, here's how the carry-trade forex game works:
Large, professional investors (apparently largely Japan-based) borrow Yen at 2-3% per annum, sell the Yen (JPY) and buy the New Zealand Dollar (NZD), earning 4-5% on their NZD holdings as interest rates in NZ are much 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!
Carry-trade Casualty: NZD
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 24 hours NZDGBP has declined by nearly 100 points (2.5%), so the NZD slide south has begun in impressive fashion.
How far might it go? 900 points or more is a distinct possibility: I'm looking for a low in the 0.3000 to 0.3100 range - well down from the recent 0.3929 high.
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: Murray Nickel holds a short position in NZDGBP.
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 excel at trading global markets.
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