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Will Dubai’s Pseudo-Default Mark The Top?




While everyone in the US was gathered around the dinner table with family and friends, getting ready to loosen the belt to officially start Thanksgiving, Dubai World released a short, terse statement requesting a debt moratorium of 6 months. This not only sent ripples throughout the global financial system, but it immediately caused their debt to crash:

dubai world default nakheel bond price chart

Nakheel is the real estate developer (owned by Dubai) behind the famous artificial island formations off the coast in the shape of a palm tree (Palm Jumeira) and the world. Of course, a picture is worth a thousand words, so this satellite image (zoom out) should explain what is going on with Dubai's desert dream.

Of course, there is an interesting dilemma here because the Nakheel bonds, as well as every other debt related to Dubai World is in strict accordance to Sharia law. This means that they are not structured as interest bearing bonds but more like quasi debt vehicles where the debtors are 'partners' with the owners. So it will be interesting to see the wrangling between the bond holders and the banks as they try to define the murky world of Islamic banking. Was the stampede into US government bonds a precursor to this?

At risk are RBS, HSBC, Standard Chartered, and a handful of other large banks. Of course, as the maxim goes, when you borrow $1000 from the bank and can't pay, you're in trouble. When you borrow $80 billion and can't pay... the bank is in trouble. Things are fluid but it seems that UAE nor Dubai (as in, the government) will not stand behind the Dubai World debt. It is all confusing because in the UAE and Dubai, the government is the de facto owner of the vast majority of the country through a feudal system of monarchy/dictatorship. This is an important distinction because one single man is the whole reason why Dubai has been thrust forward at break-neck speeds to modernize and urbanize: Sheikh Mohammed bin Rashid al Maktoum, the ruler of Dubai.

So for all intents and purposes, this is a sovereign default. But it is masked because of the way that Dubai is governed and because of how the debt was structured through a holding company. The surprising thing is not that this is happening but that it is a surprise to anyone. After all, property prices plummeted up to 50% in Dubai last year. Huge lots either remain empty or undeveloped and parts of the artificial islands are already starting to disintegrate into the sea.

dubai real estate

The Iranian Connection
While it may not be common knowledge, Dubai has been for a number of years the playground of the children of the Iranian ruling class. In fact huge sums of money that have been stolen by them from the Iranian coffers have ended up being invested in Dubai's real estate. It will be interesting to see how Iran pressures Dubai to protect its investments and if this will lead to any further geopolitical tensions.

In any case, with or without Iran's interests as a wild card, this has the potential to escalate into a full blown contagion. Or to be merely the continuation of the same malaise that we've been under for the past 2 years. Global real estate, and especially commercial real estate is already on shaky footing and this can be the catalyst to tip it over the edge. Not to mention the critical situation in Greece and Vietnam that has received less attention.

Burj to Nowhere
Any contrarian investor worth their salt would have already seen this coming from a mile away. Even if we ignored all the other signs the project to build the tallest building in the world (Burj Dubai) should have rang contrarian alarms at deafening volume. Historically, such grandiose projects are started at or near the peak of a cycle because credit is easily available and cheap, sentiment is extremely optimistic and no one can see any reason why it wouldn't be a total success. The Burj Dubai is almost finished now but it is mostly empty and will probably remain so for a very long time. An even taller building, the Nakheel Tower was in the works but it was shelved earlier this year as the economic climate turned.

If Dubai's debacle does mark the top of this stock market cycle, it will be a coincidence not a catalyst. We already have been looking at how over extended the market is, how it has been losing leadership even as it extends its gains and at how this is all happening with the backdrop of incredibly complacent sentiment on the part of investors and traders. If traders needed an excuse to sell, Dubai just gave it to them.

Update:
Here's a chart of the FTSE NASDAQ Dubai UAE 20 Index, showing it topping out in mid October and now reaching levels it last saw in September:

FTSE NASDAQ Dubai UAE 20 index Dec 2009

It gapped down again in the most recent day of trading, opening at 1705 but has since recovered slightly to 1730.

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