The Global Spread Of Risk Aversion: NZD Heads South

On Speculation And Bubbles:

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 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."

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.

The Carry-trade Game:

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

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.

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

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: Murray Nickel holds a short position in NZDGBP.

Article Source: http://www.articles.ask-me-about.com

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 build consistent success at trading global markets.