I live in New Zealand, and so I watch the NZ dollar (Kiwi) more closely than most world traders.
The current level is 0.8210
The NZ Dollar is currently insanely overvalued against the USD and it is time for a MAJOR fall.
Here are the reasons:
1. NZD USD is at an all time high but stalling.
2. Right now NZD USD is at a multi-year resistance point going back to the high in 2008 of 0.8213.
3. Looking at the daily chart, there is clear bearish divergence on both the RSI and MACD. So note on this chart that at the price made recent higher highs, the RSI and the MACD made lower highs.
4. Looking at the weekly RSI chart you can clearly see two levels of bearish divergence. As the price goes higher in November 2010 and then again in May 2011, the RSI shows progressively lower highs.
5. Elliot Wave International reminded me this week that:
“When the major stock indexes stand at or near a long-term high, mutual fund cash levels are low. By way of example, the long-term peaks in 1937, 1966, 2000 and 2007 have an average cash-to-assets ratio of 4.18%. Right now the ratio stands in a place it has never been before -- at 3.4%. That's an all-time record low.”
The NZD USD rate is historically very highly correlated with the main stock indexes (over 90% correlated). So when they fall, NZD USD usually accompanies them.
6. The Dow has fallen for the last six weeks in a row. It is time for Kiwi to follow.
7. I follow Martin Zweig’s fantastic 4% model. It signals to sell equities when it triggers -4%. This week it triggered -4% for the first time in some months. NB I calculate this daily, not weekly.
8. The Traders’ Almanac has a terrific MACD Timing system for going long equities for part of the year and flat/short the other part of the year. That system has now signalled flat/short.
9. We have recently had new 20 day lows on Dow Futures, S&P500 Futures and NASDAQ futures. A new 20 day low is a signal I have found to be an indicator of further falls.
10. Other instruments are starting to show weakness against the USD, for example Euro, AUD, GBP.
11. Jim Roger, the trading legend who started the Quantum Fund with George Soros is on record as hating the USD and expecting it to be worthless one day soon. However this week Rogers publicly stated that he is buying the USD because the selling looks overdone.
12. The official NZ Reserve Bank interest rates are at 2.5% and expected to stay there until the end of the year. There is very little carry benefit for being long NZD. The last time NZD USD was at these levels in March 2008, interest rates were at 8.25%.
This makes me think that the only reason people are long NZD USD is the “Greater Fool Theory”. The theory that there will be someone else willing to buy at an even higher level – no other reason than that.
Sure New Zealand is riding the commodity boom and our milk exports are in demand at very high prices, but it strikes me that all of this good news is already priced in to the market.
13. There is a psychological phenomenon known as “anchoring”. People tend to “anchor” to recent prices. Traders have lost perspective that only two and a half years ago NZ USD was trading at 0.4860 (59% below the current level). The average exchange rate in the last ten years has been around 0.6000. If you look at a ten year chart, you tend to get a better perspective.
14. Looking further at psychology, we all know that a very small percentage of traders/fund managers make a huge percentage of the money trading. By definition therefore you cannot make money trading if you follow the herd. If you could make money trading following the herd, then most people by definition would make money trading. So right now the herd are long NZD USD. We know this to be certain because the level is at a record high.
Selling it now does two things. First it puts you in the minority, second when the herd changes direction as it eventually must, you are ahead of the herd and make the easiest money.
I like what Paul Tudor Jones said:
“I believe the very best money is to be made at the market turns. Everyone says you get killed trying to pick tops and bottoms, and you make all the money by catching the trends in the middle. Well, for twelve years, I have often been missing the meat in the middle, but I have caught a lot of tops and bottoms.”
Also, when every trader and fund manager and their mother is long, and there is a stampede for the exits, you can make money faster than just about any other time. Look at these examples of NZD USD falls:
· In early 2003 NZD USD fell over 1,100 points in under three months.
· In early 2005 NZD USD fell 950 point in two and a half months.
· In mid 2007 NZD USD fell over 1,450 points in less than one month.
· From March 2008 to November 2008 NZD USD fell from the current level of 0.8210 to 0.5340 – all fall of 2,870 points.
· In early 2009 NZD USD fell over 1,150 points in less than two months.
15. This means that there is a colossal reward to risk ratio going short NZD USD. So to put up some numbers, if you took a $100,000 short NZD USD position today with a stop above the existing high, say at 0.8307, and with a target of 0.5000, the risk reward looks like this:
Ratio: 54.39 to 1
So to be clear I am not necessarily calling NZD USD to 0.5000. I am simply pointing out that the potential reward to risk ratio is really exciting.
16. Question: Have I ever taken a similar trade?
Answer: Yes. On 24 July 2007 when the rate was 0.8086 I bought a $1m put option with a strike of 0.7950 and an exercise date of 17 August. The option cost me NZ$5,458. I sold the option three days later on 27 July for a profit of $13,595. This might look good, but 18 hours later the option was worth $33,000. Also if you look at the chart, had I held my option to expiry I would have made around $150,000.
This reminds me of two things. One, selling at or near a high can be very profitable if your timing is right. Two, do not take your profits too early. There is a TON of downside potential on this move.
Today is Sunday and I have just finished this analysis. Currently I am not short NZD USD. I plan to take a short position in the next two days. I will most likely take a margin position and not an option.
My stop will be at 0.8307 until we break higher in the next two days.
NB There is nothing definitive to suggest that we have seen the high. The rate could go above 0.83, above 0.84 or above 0.85. I do not have a crystal ball and I cannot make a prediction on how high it will go before it falls. However in my opinion the risk reward is currently in my favour to go short here. If I am stopped out I will try again, and again.
Let me quote Paul Tudor Jones again:
“I consider myself a premier market opportunist. That means I develop an idea on the market and pursue it from a very-low-risk standpoint until I have been repeatedly been proven wrong, or until I change my viewpoint.”
“Creating the Perfect Trade”