It's a z-index issue. You can give your helper a custom class:
$( "#catalog li" ).draggable({
appendTo: "body",
helper: "clone",
start: function(e, ui)
{
$(ui.helper).addClass("ui-draggable-helper");
}
});
Then give it a z-index larger than the ui-dialog:
.ui-draggable-helper {
z-index: 5000
}