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Nerves of Clay

The reaction to the Dubai debt situation underscores the lingering nervousness of investors around the world.

Dubai World, a government sponsored investment vehicle, announced on November 27 that it would seek a 6-month standstill on debt payments. Panic ensued.

The media quickly invoked the “Dubai debt crisis”. Markets in Asia, the first to respond to the news, plummeted, although they soon recovered. Gold was drawn into the panic selling, dropping more than $50 an ounce before recovering much of that loss.

Dubai World has now clarified that it is in talks with lenders regarding $26 billion of debt. That amount is insignificant in relation to the $1.7 trillion of losses incurred by banks in the financial crisis. Abu Dhabi immediately pledged support for its neighbor, as well as for banks in the region that may be affected.

The concern remains that Dubai World may not be the only victim of the slumping real estate market in Dubai. While other firms may well be facing difficulties, it is important to remember that lenders in that region are far more cautious than American banks. Further, there is enormous wealth in the region, with much in highly liquid forms. Governments in the region have considerable resources to prevent the situation getting out of control.

After the initial panic selling on the Dubai news, the gold market appears to have gained even more supporters. Whether the Dubai World situation spreads or not, it has served as a reminder to investors that the effects of the financial crisis linger on.

History suggests that the gold market should correct after a spectacular rise such as we enjoyed over the past three months. However, the world is very different now than at any time in the past. Many investors are still nervous, or even full-on terrified. Gold provides comfort to those who have lost faith in currencies and other paper assets.

If and when a correction takes place, it is worth noting that the Reserve Bank of India happily paid $1,045 an ounce for 200 tonnes of gold. They and others would likely buy more if they had another chance at that price level. In other words, gold might correct after the big run, but a free fall is highly unlikely.


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