Where There’s Smoke…

 

A week ago, many in the financial media were quick to sweep Dubai World’s debt problems under the rug. "The U.S. markets have little exposure," they said. It was assumed that the debt could simply be restructured and the global economic recovery could go on its merry way.
Unfortunately, it’s never that easy.
When investors see smoke, they figure there must be a fire somewhere, so all of Dubai’s state-run companies are now under suspicion. Debt ratings are being cut which will in turn raise borrowing costs, and make any future debt restructuring more difficult.
And the fact that Bloomberg has this headline – "Emerging-Market Stocks Fall on Dubai, Greece, Spain Concern" – on the front page tells us that investors are once again becoming concerned with debt problems around the world.
*****According to Bloomberg, Greece’s finance minister said there was "absolutely’ no chance that Greece would default. Do you believe him? Because the fact is, we heard exactly the same assurances from Bear Stearns and Lehman Brothers before they went swirling down the tubes.
The issue here is a familiar one to Daily Profit readers: business models were based on certain assumptions about the value of assets, most often real estate. When the value of the asset falls from lofty assumptions, what was potentially a viable business model becomes a failed one.
How does Dubai World continue to meet its obligations when the value of Dubai real estate falls by 50%? Quite simply, it doesn’t. What was once a profit – is now a loss.
*****I’m reminded of the IMF’s estimates for total bank write-offs released back in the spring. I discussed in Daily Profit how the IMF said that $4.1 trillion in debt had to be written off. $2.7 trillion of that was from the U.S. At the time, U.S. banks had written off around $500 billion.
No doubt U.S. banks have now written off more than $500 billion – and we can be reasonably certain that U.S. banks have more to go. Much more.
I suspect it’s likely that U.S. banks are farther ahead of the write-off curve than the rest of the world. So the debt problems for Dubai World, Greece and Spain may be the tip of the next iceberg.
The bottom line is that losses must be taken. The global economy must be restructured to account for the true value of assets such as real estate. That’s what is meant by the term "de-leveraging." And it’s not going to be easy.   
*****How does this ongoing process affect your investments going forward?
The most obvious fallout from rising concerns about global debt is that the U.S. dollar will strengthen. That may sound counter-intuitive, but the dollar and Treasury bonds are safe-haven investments. So is gold. 
Gold has an inverse-relationship with the U.S. dollar. That is, gold prices rise as the dollar’s value falls. But gold is also a safe-haven in times of crisis. And the news from Dubai World, Spain and Greece clearly show us that the financial crisis is not over. We may be past the panic stage, but we’re not done with write-offs and de-leveraging.
We are going to see the traditional inverse relationship between gold and the U.S. dollar weaken.
*****I told you yesterday about the ridiculously cheap gold stock I recently recommended in SmallCapInvestor PRO. It’s less than $1 a share, it has 1.5 million ounces of gold reserves, and the market cap is just $179 million. That’s $1.7 billion worth of gold selling for just $179 million!
The company has also filed for listing on the NYSE, which will give it an immediate boost in share price by as much as 30%. I’ve got a $2 price target for the stock, but it could easily do even better than that. Click HERE for more.
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