Gold and dollar to gain in a financial meltdown

In an article last month entitled 'The Rising Risk of a Systemic Financial Meltdown', he claimed that there is now 'a rising probability of a catastrophic financial and economic outcome'.

This he sums up as: 'A vicious circle where a deep recession makes the financial losses more severe and where, in turn large and growing financial losses and a financial meltdown make the recession even more severe.'

Professor Roubini will doubtless detail his 12 steps in this downward spiral to his audience in Dubai on Wednesday.

Meltdown scenario

Here is a brief summary: US house prices continue to fall in value and lose 20-30% of their value, causing further huge write-downs at the banks and major problems for consumer credit. UBS estimated the total might reach $600bn last week.

Then monocline insurers guaranteeing bank debt are downgraded, resulting in another $150bn of write-offs; the US commercial property market crashes; US leveraged buy-out loans default; overstretched US companies then default costing up to $250bn; and special investment vehicles, now under strain, collapse.

This would be followed or more likely accompanied by a collapse in the US stock market, the failure of hedge funds and downward pressure on all asset prices due to margin calls. Liquidity in financial markets would deteriorate greatly from today's already troubled position.

Could Professor Roubini be right? Well, he was one of the earliest in spotting the US recession on the horizon in July 2006. And if you fit current conditions in financial markets into the start of his thesis then you have to wonder if he is not more likely to be right than wrong.

Investment response

How can you protect yourself from this catastrophe? Living in the oil-rich Gulf is not a bad start. For while a major US recession would impact on oil prices and global trade flows, the inflation created by monetary responses to the crisis is likely to support commodity prices, and the Gulf States could emerge as a relative winner from this debacle like in the late 1970s.

It is also arguable what the fate of the US dollar would be in this scenario. Logic suggests immediate dollar weakening at the start of the process, which we are seeing now.

But as asset markets implode then there is a parallel flight to the US dollar as a safe haven, and do not for one moment imagine that the rest of the world can escape the impact of this financial meltdown - if the US catches pneumonia then the body count in most emerging markets will be very high.

So if Professor Roubini is right then probably the world's reserve currency the US dollar and precious metals remain the place to hold your money. And if you do not like the US dollar then precious metals are your only option. Hence gold is approaching $1,000 an ounce and silver $20.