Eyes Wide Open: How Significant Is The Potential Dubai Default?

The quick answer to that question is that we don't have enough information to make a real assessment.  We know that the Dubai World fund is looking to restructure payment terms on $80 billion in debt.  Dubai World is an investment vehicle owned by the Dubai Government.

That's the devil we know.  The devil we don't know is to what extent Dubai World has off-balance-sheet liabilities.  Even more consequential, we don't know to what extent banks and hedge funds globally have engaged in Credit Default Swaps tied to the debt issued by Dubai World.  Like every other financial accident that has happened - and the bigger ones waiting to happen - the OTC derivatives abortion has the potential to magnify the damages by many multiples and to inflict damage in places where we we least expect it (i.e. U.S. investment and pension funds).

We also know that going back to Long Term Capital and Enron, when smoke started billowing from these entities, it didn't take long for those firms to disappear, incinerated by hidden, off-balance-sheet nuclear landmines.   The long list of financial firms that followed, often vaporized overnight, included Bear Stearns, AIG, Washington Mutual, Lehman, Wachovia and many hedge funds.

JP Morgan is out with a report that the U.A.E. has plenty of money available to bail out Dubai. That may be the case and this crisis may blow over as quickly as it surfaced.  But these sovereign bailouts, led by the multi-trillion dollar U.S. bailout schemes, will eventually become ineffective, drown out by the flood of money printed in order to make them happen.

One thing I do know, all the anti-gold critics and media morons have been quick to point out that gold was sold off hard and thus was not performing as a flight to quality instrument.  What I would like to point out is that gold has actually rebounded 4% off of its overnight lows and is unchanged from where it was trading for most of the day on Wednesday (albeit a bit below Wednesday's close).  No doubt gold was affected by the knee-jerk reaction of hedge funds who piled into gold's upward momentum and other weak-handed holders.  Hedge funds tend to sell anything not nailed down at the first sign of downside volatility, and this would include gold futures thereby exaggerating gold's sell-off.

Quite frankly, in the context of the dollar spike and the hard sell-off in stocks globally, I think gold is holding its own quite well. In fact, gold is outperforming the dollar quite handily since the equity markets opened today.  Keep your eyes wide open to what is happening in Dubai.  Not so much for what is obvious, but for the collateral effects that might not filter out thru CNBC, Bloomberg News, et al.  The event that triggers the next huge cliff-dive in global equity markets is likely to come out left field with little or no warning.  Did anyone expect to wake up yesterday to see European bourses down 3-4% on the news of potential debt default from Dubai?