Saturday, November 28, 2009

Dubai is worse than you think; batten down hatches

I didn’t realize how bad the meltdown in Dubai was until I read this morning’s Heard on the Street column in the Wall Street Journal, “Dubai Panic is Overdone.” Have you ever known Wall Street to say anything else when disaster occurs? Can you remember the headlines two years ago saying “Financial Panic Overdone?” That was before the sector cratered 80%.

The financial damage to the developed as well as the emerging world from the possible bankruptcy of Dubai World is much worse than you think. “We find it fascinating how little coverage here has been in the major news media here in the US of the situation in Dubai. It is as if nothing has happened, when indeed something truly major has,” says Dennis Gartman, editor of the eponymous financial newsletter.

Gartman reports that the United Arab Emirates had $123 billion of cross-border banking lines as of the end of June. UK banks owned 41% of this debt. When continental Europe is added, the exposure is 72%. The United States and Japan–whose currencies have soared yesterday and today–own just 9% and 7%, respectively, of this debt.

So: Gold plunged 4% in the immediate aftermath of U.S. markets reopening after the Thanksgiving close. That’s because of the dollar’s sudden strength. Gold immediately began to rebound as the not-as-bad-as-you-think chorus began to be sung, but it will fall again.

It’s worse than you think because retail investors, who react most slowly to news of this sort, are the most apt to react to it violently. Emerging markets are up 80% this year. Suddenly it’s obvious that emerging markets aren’t actually safer than the U.S.; they are just as wild as they have always been. The symbol of Dubai’s excess is quite vivid: Garish artificial islands in the shape of palm trees holding up fantastically expensive real estate that is suddenly worth 40% less.

Meanwhile, across not too many miles of sand, Saudi Arabia is locked in combat with rebel forces in Yemen. This is part of a holy war between Sunni and Shiite Muslims. To a considerable extent, the Yemen rebels are a proxy for Iran, a particularly unstable country in a stretch from Iraq to Pakistan of unstable countries spoiling for a really big fight.

So I would expect that investments in the Middle East will be dead money for years, not months. A lot of air could come out of emerging markets. The dollar could have an extended rally, eroding profits from bonds as well as stocks in Europe. That would deflate the rally in gold, which is up 35% this year.

So while I’m a long-term dollar bear, I’m a bull for at least the weeks immediately ahead. A strong dollar also means zero concern about inflation, which is strictly a currency condition. In short, the fallout from Dubai could create an opportunity to buy gold for the long term at a much better price than you can get now, and make other inflation hedges, like other commodities, more affordable as well. To raise the cash for these future purchases, I’d take some profits in emerging markets.



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