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ZAR: Today's Most Oversold Exotic Currency

ZAR: Today's Most Oversold Exotic Currency

2014-01-23 21:00:00
Joshua Brown, Head Forex Trading Instructor
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Talking Points:

  • The Case for an Oversold South African Rand (ZAR)
  • 4 Reasons USD/ZAR Makes a Good Trade Target
  • Prominent Drawbacks of Trading Exotic Currencies

The South African rand (ZAR) helps comprise what may be the first great exotic currency trade of 2014. For a minor currency, ZAR often trades like a major, and it's currently trading at lows not seen since the global financial crisis of late-2007 and 2008.

As seen on the long-term monthly chart of USDZAR below, the pair is trading roughly at 10.8300 as part of a healthy long-term uptrend.

Guest Commentary: Steady Long-Term Uptrend in USD/ZAR

ZAR_Todays_Most_Oversold_Exotic_Currency_body_GuestCommentary_JoshBrown_January22A_1.png, ZAR: Today's Most Oversold Exotic Currency

From a trading perspective, it’s crucial to consider why ZAR is losing so much ground versus the US dollar (USD), and this should naturally lead to the question of whether it is oversold, and consequently, whether or not it's a good trade target.

Along those lines, ZAR may represent a fine trade target right now because several exotic strategies can be applied:

  1. Trade an exotic currency that is moving to a significant oversold or overbought valuation. Right now, ZAR is considered to be severely oversold, and we will discuss this in greater detail below.
  2. Trade the currency of a nation that has recently or is currently undergoing a political or economic crisis. As one of the world’s key emerging economies, South Africa is struggling to recover from the slowest expansion since the 2009 recession. The nation’s vital mining industry is in trouble, as the union representing workers of some of the largest mines threaten to strike over wages. Worries also exist over accelerating South African inflation data.
  3. Trade an exotic currency that is highly correlated to commodity prices or is evaluated on the country's commodity production and its relevant global price. It is assessed that mining in South Africa accounts for about 60% of the nation’s total exports, and as mentioned above, the mining sector is in some trouble. This also affects the ZAR price due to unnerved investors.
  4. Trade an exotic currency whose home country has relatively high or low interest rates. This opportunity should be assessed on interest rate differentials. Many emerging and developing nations offer higher interest rates in order to attract investors. Unforseen shocks (such as war, natural disasters, unusual economic data, rioting, and/or labor strikes) may also force a government or central bank to act radically. If inflation rises dramatically, the South African government may increase its monetary policy activity as an instrument to regulate this more effectively. Currently, South African interest rates are 5%, while the inflation rate is 5.4%.

According to Bloomberg, the inflation rate rises 0.2 percentage points for every 1% decline in the rand. If the currency continues to fall, the privately owned central bank of South Africa may have to consider taking action. Already, the rand has slumped more than 3% in 2014, making it one of the biggest losers among developed or major emerging-market currencies.

Right now especially, there is a lot of negativity associated with the rand due to poor South African economic data. Stagnant growth, a widening trade deficit, and recent labor concerns combined with good economic US news are all putting upward pressure on USDZAR.

On the other hand, according to Danske Bank, the currency's second-most-accurate forecaster in 2013, the rand is set for a rally to 10.55 per US dollar by the end of March. Several technical indicators including the relative strength index (RSI) and the stochastic oscillator also suggest that USDZAR is currently oversold, which represents a desertion of the rand not seen in 11 years.

Primary Drawbacks to Trading Exotic Currencies

As with all exotic currencies, trading ZAR carries a few disadvantages that are often offset by some unique and encouraging incentives. The most well-known drawbacks are that trading exotic currencies bears an objectionable amount of risk (especially in highly leveraged accounts), and exotics are typically expensive to trade given high spreads and high overnight premiums. Exotic currencies are also illiquid, and this can lead to some frustration, uncertainty, and confusion.

Another disadvantage is that exotic currencies are more susceptible to market manipulation, lack a degree of transparency, and information affecting a national currency is often not freely available (except to perhaps an African dictator and his cronies).

For those who are willing and able to put these issues aside and bear the risk, however, exotic currencies like the rand may offer great opportunities, especially at times when major currency pairs trading concurrently may offer no discernible direction and trade flatly.

Possible Short Opportunity in USD/ZAR

As seen on the weekly chart below, USDZAR is trading at the top of its upward range, and similar price action can be seen on the daily chart (not shown) as well. Analysts believe that an upward breakout is possible, albeit unlikely. However, a drop to the lower end of the range would be more feasible.

Guest Commentary: Prevailing Range Boundaries in USD/ZAR

ZAR_Todays_Most_Oversold_Exotic_Currency_body_GuestCommentary_JoshBrown_January22A_2.png, ZAR: Today's Most Oversold Exotic Currency

Overall, this could be a great time to jump in and cautiously purchase ZAR, which trades widely during the day, but when held over time, could produce exemplary returns in 2014. A soothing of the labor crisis in South Africa would certainly help reinforce this prediction.

By Joshua Brown, Guest Contributor, DailyFX.com

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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