Well, Possession just says "would gain" on the card, so I think it should work like Trader, relevant part of text on Possession: Any cards he would gain on that turn, you gain instead.
1. Possess
2. Play IW to gain a card
3. Before you actually gain it (and take any actions in response to gaining it), Possession's "would gain" takes over and just lets the possessing player gain the card instead at which point he can react with Watchtower or Trader
I think it's even more important for a card like Ill-Gotten Gains, which reads: When you gain this, each other player gains a Curse.
Imaging doing this on a possession turn:
(0. Play Highway)
1. Play IW to grab an IGG
>>> Now Possession's clause kicks in, giving the IGG instead to the possessor, the "gain" from IW is caught and replaced by Possession
2. Because the possessing player gains an IGG, the opponent (who is possessed) gains a Curse
>>> Possession kicks in again, giving the Curse instead to the possessor
So the gaining of the Curse by the possessor actually happens from trying to let the possessee gain that Curse and not as a reaction from the possessee gaining that IGG. The possessee never gains anything, so he can't do any "when-gain" stuff.
3. Okay, we're back to Ironworks and it doesn't have a clue what just happened, so it just fizzles.