Dubai, Risk Assets, and the Liquidity Illusion Redux
Is there a way to make money, on the long or short side, from the quasi-sovereign debt issues in Dubai? Because the situation has already broken and isn’t generally accessible to individual investors, there’s a more worthwhile path to consider than trying to short a bank with UAE exposure (which tends to be relatively small in concentration for global banks) – and that’s understanding the signals being sent.
In general, it’s a sharp reminder that credit risk is real, especially unconventional investments in emerging markets. That should give pause to the risk asset rally that has dominated discussion for the majority of 2009, an event that has clouded the perceptions of what safe haven assets are. What bounced on the news? The U.S. dollar (UUP). What “safe haven” sold off? Gold (GLD). I understand the appeal of gold, but am skeptical of its ability to be a true store of value in times of crisis. The “hard sell” many goldbugs, and TV advertisements, give on the usefulness of the metal should be another red flag; good assets are bought and not sold.
The bullet-point story isn’t always accurate – consider liquidity, which is the de facto explanation for the surge in asset prices this year. The last time we heard about an overabundance of liquidity was 2007, when the private equity bubble topped out; one year later we had a liquidity crisis. Liquidity disappears in times of market stress, and the source or cause of stress is not predictable. In other words, liquidity does not create a sustainable rally, it’s a short-term technical factor… and although it might be a significant driver of trading, it is imprudent to rely on liquidity to continue driving prices higher, just as it would be to expect a marginal company to always have access to financing.
The Dubai story, at its heart, is one of uneconomical activity. We are guilty of our fair share of that in America, but Dubai’s existence was predicated on the ability to defy nature through aggressive debt-financed building, and it seems the costs have not been fully considered. I’m not sure what value lies in Dubai, because it has higher structural costs than other locations because of its geography and environment, but combining poor economics with a lack of respect for shareholder rights is a recipe for disaster – understand what you own, and make sure your ownership rights are secure.