Dubai’s inability to repay debts reflects upon the leveraged commercial property market across the world. In China, the Mideast or the US, newly constructed commercial properties are suffering from low occupancies and thus unbearable pain for leveraged builders. Dubai's problem is neither new nor sticky. Abu Dhabi’s “case by case” help could ease the short-term crisis. However, the case brings forward several questions which remained unanswered and were ignored in last 8 months of steep rally. It was a wake-up call for those finding moneymaking easy once again and economic recovery a smooth process. Let’s look at likely implications and scenarios that may fold out in coming days/weeks.
A harsh reminder
Similar to Ireland, Greece, Spain and some other smaller East European countries, Dubai too was a case of ambitious growth (especially in real estate) based on borrowed money. On several fronts this is similar to the state of Asian “tiger economies” of 1997 who built world-class infrastructure using “hot monies”. No surprises that all met the same fate – quasi sovereign defaults. Dubai's event may not be a “black swan” but rather, another chapter in the credit crisis; it is material enough for the world to stand up and keep a close watch on. While it is easy to make an optimistic case of this situation, dumping it as a bump in the road to recovery, the event could have some medium-term impact. Here are a few that we think are significant:
1. Dubai brings the world’s attention back to the struggling commercial property market globally. Commercial property prices in Dubai have collapsed about 50% in the last year. The correction in China was much milder (20-30%) while those in the US fell by 42.9% since 2007. Given low demand, high leverage and a history of loan defaults, US and Dubai cases are comparable (arguably). For quite some time, Wilber Ross has been seeing US commercial property as the next bubble to burst. We feel that the Dubai event could have a psychological spill-over to the beleagured US market as well.
2. Dubai has been one of the largest Asian international trading hubs and an open trade centre. Accordingly, trade finance and document collateral (Letter of Credit, Bank Guarantee) has involved several of the local, UAE and foreign banks who have (or are suspected of having) a large indulgence in the domestic real estate market. Trust in these banks may not be easy to re-establish – especially after downgrade by rating agencies in the last week. This could affect trades and money flows. Significance will be closely watched.
3. We think that in some ways Dubai was seen as a “gateway” to emerging economies. With dense population, ambitious growth plans, brand new infrastructure, and low barriers to trade, it lured investors interested in emerging economies. The event may affect perceived default risk for the Mideast region and also that of other Asian emerging economies. Undoubtedly, the risk of “unknown” in emerging economies could be priced higher.
4. Lastly, analysts are relaxed looking at the relatively small size ($80-90b) of exposure. UBS notes that the Dubai World could have “sizeable”off-balance-sheet liabilities. Besides, a “standstill” for lenders could also mean the same for several foreign firms involved in related services like architecture, interior design, electrification, automation, tourism, physical commodity trading etc. Several UAE banks have fund and non-fund based exposure to Dubai real estate market; they risk loss of credibility. Like others, we too are closely watching the spill-over effect.
The event has made investors more watchful of bumps and turns. This is evident in the credit spread market, which has remained watchful. Caution (rather than danger) could push Longs to get off the bus, slowly and gradually, especially towards the year-end. We would imagine a profit-taking wave to pick momentum gradually.
The last week
We have beeen warning of rising volatility in Commodities towards the year-end; last week was a good testimony of this, symbolising a typical bull-bear fight, triggered by the Dubai event. Copper saw a new 2009 high ($7055), Gold made a new record ($1195) before risk-reversal caught-up. Clarification from the Kingdom and a statement from US banks helped calming the nerves on Friday evening. Although the market recovered most of its losses, bullish technical patterns for most of the base metals are not convincing now and are sounding bearish in some cases, especially Lead.
Antaike expects rising Aluminium demand in China in 2010 and yet more surplus. The Chinese reseearch agency suggest infrastructure demand to lift Chinese aluminium consumption to rise 8.7%; but Chinese exports of Aluminium to grow. Meanwhile, Chinalco admitted restarting most of its idled capacities.
The Spence strike got over, bullish markets ignored it. Metal exchange stocks rose again, markets shrugged it off as well. As suggested by us in our previous report, high Zinc prices have been attracting stocks to warehouses (LME and SHFE).
After warnings by some of the Asian banks of intervention if currency appreciates beyond their bearing capacity, BoJ sounded a note of caution after JPY appreciated to a 14-year high against the Dollar. Dollar index is being supported around 75, but is still in a downtrend channel.
Large inflows of Nickel in LME (3300 mt in the week) helped ease the physical premiums for the metal, which were earlier supported by Sudbury strike. China is rumoured exporting most of the base metals and steel – either to warehouses or to other user countries. Indian physical market for Copper is mired by high prices, slowing re-stocking and large availability of scrap. It is getting difficult for physical traders to rotate material. Premiums for most of the base metal remained steady, close to previous week’s level.
Market moodIn our last report we saw bullish technical patterns in most of the base metals. Last week prices broke above the pattern and pushed higher. However, the Dubai event acted as a dampener and caused a big “yo-yo” on Friday. This “diluted” bullish short-term patterns for Lead and Aluminium; other base metals appear in neutral zone. We would watch for any “rejection” of the late Friday rally; if that happens, Lead and Aluminium will top our list for going short.
Last week we said: “….While all these suggest a possible strength in dollar, we would watch for break-outs (JPY >94, USD Index > 76.50, Euro < 1.46) before betting against the trend.” We continue to hold our view that currencies are the torch-bearer for all asset markets and a place to watch closely.