Markets the world over had a scare last week when Dubai World, the Persian Gulf-based real estate outfit that is presumably backed by the emirate of Dubai sought to defer payment on its debt for six months. The fear was that Dubai was another domino to fall in the global financial crisis, which could have ripple effects throughout the world’s financial system.

 

With little in the way of energy assets, the city-state of Dubai has risen out of the desert sands in recent years to become a major financial services, tourist destination and logistics hub. The building boom there in recent years, which would put the Las Vegas casino builders to shame, has busted with a precipitous drop in real estate values and an office vacancy rate of 40 percent.

 

This week, calm has been restored as the size of the debt problem has been assessed to be much lower than previously believed and as Abu Dhabi, Dubai’s larger neighbor, is stepping in to save the day.

 

The tale of excess in Dubai didn’t happen in isolation and there could well be others like it to follow. But a key takeaway from the story is that interest rates will remain extremely low for the foreseeable future. If anything, the Dubai debt issue highlights the need for central banks around the world to keep interest rates very low and for continued fiscal and monetary stimulus. Japan now, for instance, is looking to inject more than $115 billion in “quantitative easing” — money printing.

 

In the absence of a meaningful correction in stocks to shake investors’ confidence, the low rates here in the U.S. will only encourage them to take on greater risk in search of returns. Interestingly, investor sentiment, as measured by the Investors Intelligence Bull/Bear ratio, is leaning heavily to the bull’s camp. Unfortunately, this is typically a contrary indicator. In fact the last time the reading was this lopsided in favor of the bulls was near the market’s peak in September 2007.

 

Seasonal strength notwithstanding, this latest data point only serves to reinforce our view that stocks are far ahead of themselves. Unless we see solid indications that the economy is accelerating (which we doubt will occur), share prices could be in for a sizable correction some time in the early going of 2010. Adding to our concern is the ongoing strength in commodity prices, which can only hinder the recovery.

 

After selling off slightly on the Dubai news, gold found firmer footing yesterday and is once again headed toward $1,200 an ounce. Although we won’t rule out a bigger correction in the near term given the metal’s stellar run in recent months, the case for gold remains quite strong. And so long as the U.S. dollar remains weak, gold will continue to attract converts.