Forex articles.

3/05/2008

The Global Spread Of Risk Aversion: NZD Heads South

By: Murray Nickel
The Speculation Game:

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.

While the USD is out of favor at the moment, it may return to its role of traditional safe haven if economic crises unfold in some of the many developing countries with impressively bubble-like 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."

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!

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, 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.

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.

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).

Down Under For The NZD:

My TrendSensor trading systems generate buy and sell signals based on technical analysis of markets. My trading signal clients receive these signals and we currently have an open short position in NZDGBP. Add in the fundamental analysis on carry-trades covered above, and you have a pretty strong case for a short position in NZDGBP - or NZD vs any major currency for that matter.

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

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.

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 currently hold a short position in NZDGBP.

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