The Australian, Sydney
Saturday, November 22, 2008

Fears of the unknown long-term effects from the global financial crisis have sparked a new gold rush.

With retail and wholesale clients around the world stocking up on the precious metal, the Perth Mint has been forced to suspend orders.

As the World Gold Council reported that the dollar demand for gold reached a quarterly record of $US32 billion (A$50.73 billion) in the third quarter, industry insiders said the race to secure physical gold had reached an intensity that had never been witnessed before.

Perth Mint sales and marketing director Ron Currie said the unprecedented demand had forced the Mint to cease orders until January, with staff working seven days a week, 24-hour days, over three shifts to meet orders.

He said Europe was leading the demand, with Russia, Ukraine, Middle East, and US all buying — making up 80 per cent of its sales. One European client purchased 30,000 ounces for $33 million.

“We have never seen this before and are working right at capacity. And we are seeing it from clients in the shop buying one ounce, right up to 30,000 ounces from overseas clients,” Mr Currie said.

Robert Jaggard, manager of bullion and rare coins dealer Jaggards, said business had picked up strongly and he expected it to increase further.

“All around the world there has been a heavy run on physical gold and there is a shortage of supply,” he said.

Mr Jaggard, who has been dealing in gold for 40 years and is an agent for the Perth Mint, said some clients were buying up to $1 million worth of gold, paying a premium above the spot price.

If the UAE is the last real estate market in the world to enter a correction then is it too optimistic to hope that it might be the first to come out of a downturn? My argument is that the inflationary effects of the multi-trillion dollar bank bailouts are not to be underestimated, and a rapid return to higher oil prices would likely put the local property boom back on track.

All the same it is quite obvious to any observer of the UAE property scene that this autumn has seen a boom turn to bust. In September Dubai villas and apartments were still selling for record prices, by October the market fell sharply, according to figures from HSBC. Dubai villa prices were down 19 per cent month-on-month, and apartments in the Dubai International Financial Centre dropped by up to 30 per cent.

The month of October began badly with the Cityscape Dubai 2008 exhibition that saw an almost complete failure of off-plan sales. Even in Abu Dhabi the off-plan buyers have been very thin on the ground this season, just six months earlier at the Cityscape Abu Dhabi people were queuing down the road to buy.

Global or local causes?

Looking at the immediate reasons for the crash the finger can be pointed at global and local factors. From a local perspective the boom became oversold with prices spiking to levels that were unaffordable, and then local banks became embroiled in the credit crunch and tightened up mortgage lending criteria. At the same time, global stock markets crashed in October and international credit markets froze, compounding the local downturn.

It is presently very tough to sell any off-plan or secondary property in the UAE, and the deal flow has slowed to a trickle. Dubai Land Department figures still look fine but the deals being registered today were concluded long ago.

Real estate developers have fired sales staff. They have been leaving anyway because commissions have dried up. Estate agents who were busy over the summer are now very quiet indeed. The shift from feast to famine for the sector has been frighteningly fast, and the endless double-page spreads of real estate advertising in local newspapers have gone.

However, the supply and demand fundamentals have not changed much in Dubai. Indeed, the rental market is tighter than ever because people are not buying and renting instead. It remains to be seen how long rents can continue rising if local firms begin to cut back staff and send them home in an economic slowdown. But such is the backlog of demand for housing that this could take some considerable time to become evident in the market place.

Demand big

One study of local housing demand published over the summer showed that upcoming supply barely met the forthcoming demand from the Dubai state and state-controlled companies, let alone the private sector. Groups like Emirates Airline have massive staff accommodation requirements, and for each new A380 super jumbo that lands in Dubai dozens of apartments will be needed for the flight crews.

It would take a really big slowdown in growth from such companies to put a serious dent in demand for housing. And this study did not even start to assess demand patterns from the private sector in Dubai, with many major financial institutions planning to move large numbers of staff into the city, or the impact of Abu Dhabi’s expansion where there is so far no new accommodation available at all.

In economic jargon this is called momentum. An economic boom of the type seen in the UAE since 2002 does not come to an end quickly, even if real estate sales grind to a halt. There is huge work-in-progress, and a massive amount of money committed, a great deal of it equity and not debt.

Debts lowish

Besides debt must be kept in proportion to GDP. The UAE has debt equivalent to around 50 per cent of GDP compared with more than six times GDP in the UK and 3.5 times in the USA. And the UAE’s debt turns to a net surplus when its sovereign wealth funds are taken into account.

Long-time UAE watchers compare the panic of October 2008 to the UAE stock market crash of 1999. Then as now Emaar Properties stock took a hammering. Investors thought the end of the world was coming, and sadly a few committed suicide. In 1999 some bankers left the emirates convinced that the real estate market was going into a meltdown. But the UAE recovered from the aftershocks of the Asian Financial Crisis very quickly, and the oil price bounced back from under $10.

1999 all over again

This correspondent lived through that period and experienced just how quickly the UAE economy can recover from what looked like a very serious position. Is it so different today? Admittedly the scale of the projects and the amount of over-building is more dramatic than in 1999 but then the UAE economy is that much stronger too after seven years of booming oil prices.

Help is also at hand from oil consumer nations whose response to the financial crisis this autumn has been a quite unprecedented series of bailout packages now totaling more than $4 trillion. The US money supply has more than doubled in two months. Even in the Great Depression of the 1930s money supply increases never went above 15 per cent. It just has to be hugely inflationary, and the time lag between stimulus and inflation is nine months to a year.

That will mean high oil prices will be back within a year, and the revenues that drove the UAE real estate ever upwards will return much more quickly than any body anticipates this gloomy autumn. Anybody dumping property now could live to regret it, as higher general inflation will carry rents and capital values higher at least in nominal if not real terms, as salaries will also have to rise sharply.

It is all too easy to move from being wildly over-optimistic about UAE property to being irrationally depressed, and to forget that we live in a world of rapidly changing economic circumstances. For UAE property the correction could be short and the upturn strong as it was in 1999. Economic fundamentals are all that count in the end.

The revelation of the purchase of $3.5 billion worth of gold by a group of Saudi Arabian investors over the past month is a huge gold deal when you consider that total record third quarter spending on gold by consumers was $6.5 billion.

Since the story broke on this blog I have received an email from an individual claiming to have personally handled the Saudi deal and confirming its veracity. But nobody appears to have a clue where the gold came from or who actually bought it.

Public sales of gold coins and bars reached their highest levels for more than a decade in the third quarter while gold exchange traded funds saw record inflows as revealed by the World Gold Council in its latest Gold Demand Trends report.

Record demand

The WGC said consumers spent $6.5 billion in buying 232.1 tonnes of gold coins and bars in the third quarter of 2008, an increase of 121 per cent in volume terms over the same period a year ago, and the strongest growth since the mid 1990s. In the first nine months of this year, net retail investment in coins and bars reached 443.6 tonnes, 10 per cent more than all of 2007.

Germany and Switzerland saw a surge in demand for coins and bars in the third quarter with net retail investment of 19 tonnes and 21 tonnes respectively, up 533 per cent and 500 per cent compared with the same period a year ago.

Exchange Traded Funds also saw record buying interest with inflows of 150 tonnes in the third quarter, up 8 per cent over the same period last year, with investors spending more than $4.2billion accumulating holdings in ETFs. Lehman’s implosion in September led to a jump in ETF inflows, which surged by an unprecedented 100 tonnes in just five consecutive trading days.

Jewellery demand

Strong growth was also seen in the jewellery sector where demand reached 647.6 tonnes in the third quarter, up 8 per cent compared with the same period last year, and taking spending to $18.2 billion. India, the world’s largest jewellery market saw demand reach 178.5 tonnes up 29 per cent compared with the same period last year as consumers rushed to take advantage of lower prices ahead of the Diwali festival in October.

Why then have gold prices fallen in the third quarter? It certainly defies the laws of supply and demand. As commented elsewhere on this blog the problem is that the Comex paper futures market sets the spot price of gold, and as hedge funds have sold this paper the price of gold has fallen.

This has, however, just further whetted consumer appetite and for once retail investors are acting rationally and buying on falling prices. That prices could suddenly reverse upwards, and soar ahead is also obvious. It just needs the hedge funds to stop their disposals, which must surely be almost done.

When Dubai’s biggest mortgage lender Amlak Finance announced yesterday that it had suspended all new home loans, it is time to acknowledge what is quite obvious to any observer: the Dubai property boom has crashed. There are no sales, except at very distressed prices, and new project launches have flopped completely this autumn.

Eight weeks ago Dubai created a supreme financial committee to make recommendations on Dubai’s sovereign debt and the debts of state-controlled companies. The committee includes Amlak chairman and director general of the Dubai Department of Finance, Nasser Al-Shaikh, Emaar boss Mohamed Alabbar, UAE cabinet minister Mohammed Al Gergawi, Dubai Islamic Bank chairman Mohammed Al Shaibani and Borse Dubai chairman Essa Kazim.

Nakheel

It is perhaps strange not to see Dubai’s biggest state property developer Nakheel represented on this committee. Some might argue that Nakheel’s portfolio is the one most obviously in need of trimming back in the light of the challenging global business environment, and it almost certainly carries the biggest state debts.

Mr. Al Shaikh has told local media that the committee will not be looking after the private sector, and will be giving its recommendations directly to the Ruler of Dubai and UAE prime minister Sheikh Mohammed bin Rashid Al Maktoum. He said property projects that are under construction or announced would go ahead as planned but that Dubai may face some postponements in real estate projects.

The next 18 months are going to be difficult for Dubai but Mr. Al Shaikh subscribes to the view that Dubai can be last into the global real estate crisis and one of the first out. The outlook for oil prices, with a $4 trillion is bailouts and stimulus packages now announced, is bright and could quickly fuel up the UAE economy for a recovery.

Shake-out

However, a proper shake-out of weaker property development companies, and a rationalization of the state sector will be good for the long-term health of the Dubai economy which has been overheating with too many projects going ahead at the same time leading to pressure on construction material prices and traffic congestion, and threatening over-supply.

There is also a powerful triumvirate committee at the UAE federal level also examining how the country should reorientate its spending in response to the global financial crisis.

The task for the Dubai and UAE authorities is to quickly agree on a revised business plan and to implement it while other countries around the world dither and debate. Usually when a booming market is taken for reassessment it becomes very obvious which are the weaker and less economic projects, and which should be safeguarded as long-term winners.

Strong survive

An economy makes progress by letting the strong survive and the weak fail. Interestingly this is exactly the reverse policy to what is being pursued in many developing countries. Supporting weaker banks just makes it harder for the stronger ones to make profits. Bailing out economic basket-cases like US auto giants saves jobs today but costs them in the long run.

Let us hope Dubai and the UAE can grasp the nettle and sort out the good from the bad. It will not be an easy task, the losers are not going to be happy people. But you do not create a strong economy by supporting losers. You need to focus the available resources into the most economically productive areas of the economy and put the rest on hold for better times.

I think Dubai and the UAE will get that right by reassessing the value of projects to the long-term future prosperity of the emirates, and the sooner it is done the quicker the recovery will be.
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Did the Dubai Financial Market hit rock bottom earlier this week after shedding 68.5 per cent of its value? Certainly the 2,000 point barrier seems to have held as a support level and stocks have rebounded to 2,053 today, still 65 per cent down and way off the high late last year of 6,292. Investors are naturally feeling extremely upset and broke.

My Emirates Business 24/7 column at the start of 2008 warned of a negative year for stocks but there is reason to think that this could be the turning point. Certainly the 27 per cent plunge last week looked like a selling climax.

Selling climax

It was truly horrible and an SMS from the National Bank of Abu Dhabi proudly reported the 27 per cent weekly loss for its mutual fund, sometimes you have to wish technology was not so merciless, no human messenger would be so bold.

However, I saw a headline this morning which surely is the cavalry coming over the hill, a little late to prevent the massacre but on hand to help the survivors. Apparently Dubai is holding talks with the UAE government about low-cost funding for local firms.

Fresh money on the table is what is needed to stop the stock market meltdown, which has already gone into the irrational liquidation phase driven by margin calls. As I commented on this blog earlier in the week there is no rational basis for extreme pessimism about Dubai.

The worst that could happen is that every second tower is owned by Abu Dhabi after a bailout of historic proportions. But that is hardly going to be necessary. The UAE is not short of capital, and while Dubai’s spending will need to be scaled back, Dubai will have no problem servicing its debts.

Triumvirate

The Gulf News today reported the formation of a high level triumvirate to consider the strategic nature of projects now in progress and to decide on what is most important to save. That is a very sensible approach to managing a market correction, not a disaster.

Anybody with an ounce of common sense can see that the emirates is better positioned that almost any other country in the world to tough-out and even eventually profit-from the global recession. This country is like a person with debts on their credit card but twice as much on deposit at the bank, name another country in that position?

Panicking local share holders are their own worst enemy, just as in 1999 in the last crash. They are the problem not the local economy which will be the first in the world to bounce back from the current crisis and has been the last to get into trouble.

Hedge funds are driving global capital markets down and down with their relentless selling, so when will they stop?

This morning I listened to Citadel Capital CEO Ahmed Heikal’s presentation to the Private Equity World MENA 2008 organized in Dubai by Terrapin. He suggested hedge funds would look at their year-end redemptions after the November 15th deadline and carry on selling until they could fulfill redemptions.

Hedge fund sales

That makes good sense. Hedge funds have no choice but to sell down all their assets to repay their obligations to subscribers. If as Mr. Heikal suspects redemptions have been higher than expected then so will be the sell off.

But does that mean the selling will stop on December 31st? It could indeed mark a selling climax - the favored time for a stock market crash by Indian astrologers, although have we not already had one in October-November?

Slower meltdown

A gloomy delegate from Germany said he thought the bailout packages would string the slow meltdown of stock market values over the next couple of years, and the year-end climax would just be a part of that long process.

To be fair he has stock market history on his side. Crashes are dramatic but the bigger picture is a much longer up or down wave, and you do not need a degree in macroeconomics to see what type of wave we might now be experiencing.
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The Dubai Multi Commodities Center is understood to be putting the finishing touches to an exchange traded fund for silver with a launch likely next month as demand for silver has surged in the past six months.

Local bullion dealers are having to fly heavy silver bullion bars in from around the globe to meet demand as traditional sources closer to Dubai have been exhausted. The DMCC has successfully established itself as a regional hub for commodities trading over the past few years, and has its own swanky new business park with its gold, silver and diamond towers.

City of Gold

Around 20 per cent of the world’s physical gold trade is conducted through Dubai which used to be the epicenter of gold smuggling to India thirty years ago when import taxes were sky high. Nowadays Dubai is a convenient logistics center for commodities traders and still tax free.

The details of the silver ETF are being kept under wraps for the launch but plans seem advanced. Local jewelers have long used silver in a 25:75 amalgam with gold to create white-gold which is popular with consumers.

But clearly the ETF is an strictly an investment product, and demand for the shiniest of metals has been rising strongly, as evidenced by the high premiums now being paid on coins and bullion locally.

ETF price advantage

The latter also gives the ETF a natural advantage. Its price will be closely linked to the lower spot price for physical silver, and not be inflated by the high premiums now paid on physical silver.

Investors will no doubt appreciate this keen pricing advantage, and hope to also profit from the leverage silver offers to the gold price. In previous gold price booms silver has outperformed the yellow metal, and the gold-to-silver price ratio has fallen sharply.

Will the new Dubai silver ETF have a big enough impact on the tiny global silver market to send prices higher like the Hunt Brothers did in the late 1970s when they cornered the market? Well, nothing succeeds like success and a silver ETF in Dubai looks like being the right product in the right place at the right time.
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‘We have just been in Bahrain and everybody is cashed up!’ one banker told me today. My reply was that if everybody is now in cash then it just has to be the wrong place to be! Thinking about it there are some very good reasons to worry about a large cash position.

Quite apart from the contrarian argument that the crowd is always wrong, you have to consider what is happening to the supply of cash. We know that with the sell-offs in global capital markets there is plenty of demand for cash, what about the supply?

Money supply out of control

Another banker today showed me a chart of US money supply growth over the past few months, and highlighted a 111 per cent increase. This compared with something like 15 per cent money supply growth in the early 1930s as the US authorities grappled with the Great Depression!

There is an absolute tsunami of money coming into the system. What happens when the supply of something exceeds the demand: the price drops. And that is exactly what is going to happen to the US dollar - the authorities are about to inflate away their debt problem.

It is so simple: the debt stays at the same nominal amount, you print more money and the real value of the debt falls. Of course in the real world that also means a bond market collapse as inflation will make both the coupon and real value fall.

I wonder how long it will be until cash is deposed as king of the investment world? My guess is that it will not be long after the sell-off ends. How long will that take? It could be at the end of the year as the hedge funds attempt to square their positions, or it might be next spring after another lurch downwards in stock prices.

The bottom for stocks will be the top for cash and treasury bonds. Then inflation will start to emerge and depose cash from its temporary throne. Who will be the new king?

Gold and silver

Step forward precious metals to take a bow. Everybody knows that gold is inversely correlated to the US dollar and that silver is leveraged against the gold price. But why have precious metals taken so long to claim their crown in this financial meltdown?

The straight answer is that hedge funds have been selling assets across the board and turning gold into dollars, or at least the paper gold of futures contracts into greenbacks. The physical demand for gold and silver has been growing strongly all the time, hence the silver coin shortage and the $3.5 billion Saudi gold purchase.

Once the hedge funds stop selling, and you always do eventually run out of assets to sell, then gold and silver prices will rally, and the rush out of cash and into precious metals will do something pretty spectacular to the price. Gold and silver stocks, languishing at a 40-year low, should jump and deliver phenomenal performance for new investors and repay the patience of long-term holders.
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Hedge funds with no leverage, options or futures might sound like a product stripped to the bare essentials of short and long equity strategies, but that has not deterred the $50 million seeding of the BlackRock Global Resources & Mining Fund by the Dubai Multi Commodities Centre.

At a press conference today fund arrangers Barclays Capital and Shariah Capital refused to give a target for how much the fund intends to raise when it goes public in December. However, the DMCC has now seeded four Islamic hedge funds with a total of $200 million and hopes for billions of dollars in subscriptions.

Shariah Capital’s Eric Meyer, the driving force behind the world’s first Islamic hedge funds, says this is a big day for his industry which fills a market niche for Shariah compliant investment. His company has developed tools for screening stocks to ensure they comply with Islamic principles such as low gearing, and a technique that allows shorting in compliance with Shariah.

Scholarly advice

The group also has its own in-house Islamic scholar to monitor movements within the portfolios on a daily basis to ensure nothing ‘haram’ creeps into the asset base. At the same time, each of the funds is run by a best-of-breed fund manager with huge experience in stock picking.

For example, John C. Hathaway of Tocqueville Asset Management manages the gold fund. He points to the 40-year low in gold stock prices as a buying opportunity, and says that massive money supply inflation means dollar weakness would resume very shortly.

This is indeed a bizarre time to launch a new hedge fund. But as Mr. Meyer argues these are not traditional hedge funds because they use zero leverage. Only in the facility to go long and short are they hedge funds in the strict sense.

Commodities will boom

But the timing might actually prove auspicious with stock prices around the world at such lows, and conservative stock-picking by expert fund managers looks a good strategy, particularly when focused on commodities which may recover rather quickly as multi-trillion dollar stimulus packages inflate the world economy.

It has been notable that Islamic equity funds have performed well in the downturn because avoiding heavily borrowed companies is a plus in such times. The only quibble is that staying in lowly geared companies is not good for growth in an upturn. But then we have to get there first.
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Vice-governor of the Saudi Arabian Central Bank Mohammed Al Jasser told journalists in Dubai yesterday that the Kingdom’s $343 billion in foreign reserves were held in ‘very liquid, safe, minimal risk’ international assets. ‘Our bank exposure to international markets is extremely small’ he added.

His comments followed remarks by Saudi Finance Minister Ebrahim Al Assaf in Washington that the Kingdom has no intention of tapping into these funds to recapitalize the IMF. ‘There were lots of rumors that we are coming here to pay the bill, there is no such thing,’ he said.

However, His Excellency emphasized that Saudi Arabia would make good its promise to invest $400 billion in the oil and gas sector over the next five years. Saudi Arabia has responded promptly to the global financial crisis to secure its domestic economy, cutting interest rates, lowering bank reserve requirements, guaranteeing bank deposits and injecting billions into its banking system.

Brown’s blundering

But it appears that last week’s visit to the Kingdom by the hapless British Prime Minister Gordon Brown has backfired as his request for money to boost the IMF’s war chest has been ignored.

Al Assaf commented: ‘This is his opinion. This is not our opinion. We are not going to pay more than others. We have been playing our role responsibly and will continue to play our role, but we are not going to finance these institutions just because we have large reserves.’

Mr. Brown’s blundering diplomacy is part of his quest to flood the world with money to avoid a deep recession that will surely cost him his job when he faces his first-ever general election as Prime Minister. As Finance Minister he presided over the UK housing boom and a massive expansion of public spending, now seen as reckless domestic economic management which has left Britain the worst exposed economy in the global financial crisis.

Domestic investment for global benefit

Saudi Arabia is acting responsibly in looking to invest its money in long term economic infrastructure rather than short-term, highly inflationary spending by desperate Western politicians. New supply is the way to prevent another oil crisis, not handing money to the IMF.

It is also not surprising that local Saudi investors are also choosing to invest in sound money like gold, of which a group of businessmen recently bought $3.5 billion, apparently just before the price correction of the past couple of weeks.

Caution now reigns among Persian Gulf investors who have seen early investments by their sovereign wealth funds in Western banks decimated by stock market crashes. The feeling is that markets abroad need to find a bottom while good investments can be found closer to home in national infrastructure development.
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