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The Flight To Safety Sends NZD Southwards

By : Murray Nickel
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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.

Right now, however, 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."

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.

Heard Of 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.

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.

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

While 100 points in one day is impressive, the possibility of a 900 point slide is mouth watering! I expect NZDGBP to bottom in the 0.3000 to 0.3100 band - a long way south of the recent 0.3929 peak.

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

DISCLOSURE: I currently hold a short position in NZDGBP.

About the author:
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 excel at trading global markets.

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