Risk Aversion Ripples Across the Globe: NZD Heads South

On Speculation And Bubbles:

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.

Two other obvious and traditional safe havens are 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."

At the time I wrote that article in 2005 Gold was around $430 per ounce. It eventually spiked to $730 per ounce and if I'm right about it becoming a safe haven for investors, maybe $1000 per ounce isn't far-fetched after all? 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:

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).

Carry-trade Casualty: NZD

Anticipating this move to safe havens added to the technical picture and short signals I had received recently for NZDGBP. When reviewing the NZDGBP chart yesterday, I came up with six technical reasons why NZDGBP should decline soon, as per the recent short signals my signal clients have received. Add in the fundamental picture above re the flight to safety, and it was a pretty convincing argument.

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

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 has the potential to be a 5-8 month trade and deliver a rare money-making opportunity, so maintaining the long-term view as NZDGBP wends its way south will be critical.

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.

By: Murray Nickel

Murray Nickel is a mathematician, statistician, and professional trend trader. He offers a free trial of trading signals for global market indexes and index ETFs, spot Forex, and spot Gold. He also mentors trend traders aiming to succeed at trading global markets.
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