The Global Spread Of Risk Aversion: NZD Heads South

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The Global Spread Of Risk Aversion: NZD Heads South

Posted By: | Posted On: 2007-07-27 | Article ID: 24235

Speculative Games:

As the credit squeeze takes hold in the US and the sub-prime/derivative markets unravel a swing towards risk aversion is rippling out across the globe.

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 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.

The Carry-trade Game:

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

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 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 "risk-aversion" becomes the catch-phrase globally, speculative activities like forex carry-trades are soon abandoned in favor of "safe havens" like USD, spot Gold, or Swiss Francs (CHF).

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.

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.

If 100 points in a day is impressive, the prospect of a 900 point slide is simply mouth watering for a long-term forex trader. I anticipate NZDGBP forming a low in the 0.3000 to 0.3100 range. That's a long journey south from the recent 0.3929 high point.

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.articlecell.com

About The Author

Murray Nickel is a mathematician, statistician, and professional trader. He offers a free trial of trading signals for global 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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