While I focus mostly on high yield investments like MLPs (AMLP), REITs (VNQ), BDCs (BIZD), renewable energy Yield Cos, alternative asset managers, and utilities (XLU), I have recently been massively increasing my allocation to gold (GLD)(IAU). I already own fairly substantial positions in gold miners (GDX) like Barrick Gold (GOLD) and recently began allocating significantly more capital towards the metal itself. The reason? There is one increasingly likely scenario that – if it comes to fruition – could prove to be enormously bullish for gold relative to the stock market (SPY). That scenario is a Chinese invasion of Taiwan.
Moreover, even if China does not invade Taiwan for many years to come, if ever, we still believe the outlook for gold is quite bullish. In this article, we will discuss these reasons.
Why China Could Invade Taiwan Within Months
Hayman Capital Management founder and CIO Kyle Bass – who is also a China expert – recently stated that Communist China is likely to invade Taiwan by the end of 2024. He believes that the markets have not even closely priced in this risk because they believe that the economic cost of such an attack is sufficient to deter CCP leader Xi Jinping from launching such an attack. However, such calculus assumes that Xi is a rational actor that is motivated by economic factors. In reality, the CCP has shown repeatedly that it is far more concerned with maximizing its domestic and international power than in maximizing its GDP.
As Bass pointed out:
If you listen to what [Xi] says, I believe he will end up acquiring, reacquiring Taiwan by force by the end of next year. We on Wall Street love to think he would never do that because it doesn’t make economic sense. We have to stop thinking that way and literally start listening to what the man says…You can hear it in all of his speeches since 2017…Xi Jinping is not economically focused. Economics are kind of a means to his end, very much like Putin.
Unfortunately, however, unlike Putin’s war in Ukraine, if Xi were to invade Taiwan, it would have devastating consequences for the global economy and could very possibly bring on world war 3.
Why is China increasingly likely to invade Taiwan sooner rather than later? There are four main reasons:
- The PLA’s military drills that are required to display its competence for executing such an invasion are nearly complete and have been increasing in intensity over the past year. It only has one more military exercise remaining before it can signal to Xi that it is ready to launch its invasion.
- The government has been consolidating power within its ranks, especially in the military. Many of these purges seem to have been targeted at removing government officials and military officers who are opposed to going to war over Taiwan and replacing them with yes men who will follow orders if/when Xi decides to move forward with war on Taiwan.
- It is no secret that the PLA has been engaged in the most rapid military buildup since World War 2, with a full-throttle effort to increase readiness for war across all aspects of the military. Moreover, this effort has been further accelerated due to the CCP’s very aggressive espionage program that has resulted in untold billions of dollars’ worth of stolen advanced technology from the West. Even more concerning is that China’s military buildup has been laser-focused on not only invading Taiwan, but also on specifically preparing for conflict with the U.S. military.
- Last, but not least, China has been diligently preparing its economy to withstand wartime conditions and intense sanctions from the West. These preparations include giving the government authority to seize private assets effectively at will, building air raid shelters and medical facilities in a region near to where an invasion of Taiwan would be launched, shedding its U.S. Dollar reserves and piling up gold in its place, and hoarding food and energy supplies, among many other preparations. The sheer scale and urgency going into these preparations seem to clearly imply that Xi is at the very least striving to make a near-term invasion of Taiwan an option at his disposal.
Why A Chinese Invasion Of Taiwan Would Be Bullish For Gold
So, why is gold a good hedge against a Chinese invasion of Taiwan?
First and foremost, gold would almost certainly outperform the broader stock market (DIA)(QQQ)(VOO) in such a scenario, especially if the United States and Japan joined the fight in some capacity. I view the U.S. and Japan joining the fight as being very likely given that the CCP would likely want to launch a pre-emptive, devastating attack against U.S. naval and air forces in the region stationed in Japan and Guam in order to delay the U.S.’s ability to intervene militarily on behalf of Taiwan and potentially inflict such heavy and sudden losses that the American public may shirk back from entering an all-out war with China. If China struck U.S. forces on Japanese soil, the Japanese would inevitably suffer some collateral damage and would be very motivated to join the war alongside their American allies.
The reason that this scenario playing out would hurt the stock market so much is that the U.S., China, and Japan are the world’s three largest economies by GDP and are also the world’s three largest economies by amount of global trade they participate in. On top of that, Taiwan is the world’s main production center of semiconductor chips. Last, but not least, some of the largest companies in the world are headquartered in the United States and are heavily reliant on China and Taiwan for producing and selling their products. Tesla (TSLA) and Apple (AAPL) come immediately to mind as examples. These businesses, and thousands more like them in China, Japan, the United States, and around the world would immediately suffer massive impairments in the event of a war over Taiwan. In fact, some estimates put the immediate destruction to the global economy at $2.6 trillion, with the Rand Corporation predicting a global depression and a decline in U.S. GDP of at least 5% (which is twice the decline experienced during the recession caused by the 2008 financial crisis).
Moreover, confidence in the U.S. Dollar could take a major hit, especially if its military suffers major losses. This is because – even if it prevails eventually over the Chinese military (which is far from guaranteed) in the conflict – its ability to project power around the world and secure international trade will likely be significantly impaired from the heavy losses it will inevitably incur in such a war.
Meanwhile, gold – a proven safe haven during periods of economic distress and geopolitical uncertainty – would likely catch a very strong bid during such a crisis. Moreover, central bankers would likely be forced to slash interest rates in an attempt to calm markets and prop up faltering economies (not to mention reduce the financing cost of financing such a huge war). Immense money printing would also likely take place as part of paying for the war effort against the CCP. All of these factors point decisively to an extremely bullish scenario for the price of gold.
Other Reasons To Be Bullish On Gold
Even if saner heads prevail and Xi is dissuaded from invading Taiwan, gold still enjoys a fairly bullish setup because:
- U.S. Government deficit spending appears likely to continue unabated for years to come. This will inevitably put immense pressure on the Federal Reserve to cut rates eventually and lead to negative real interest rates over the long-term. This means that the rate of inflation will be higher than the nominal interest rate, which is a very bullish setup for gold.
- Central banks around the world are accumulating gold at a rapid clip, putting upward pressure on the gold price.
- Chinese and Indian citizens are buying gold with much of their incremental newfound wealth as those economies continue to grow.
- The BRICS nations are considering launching a gold-backed currency to compete with the U.S. Dollar in international commerce. If this were to actually happen, it would be extremely bullish for gold.
Investor Takeaway
It is not often that I make major asset allocation decisions based on a macroeconomic and/or geopolitical prediction. However, in the case of gold, it appears to have an extremely attractive risk-reward profile at the moment given the growing likelihood of a Chinese invasion of Taiwan as well as the other seemingly irreversible macro trends of runaway deficit spending in the U.S., negative real interest rates over the long-term, and the rising popularity of gold as an alternative to the U.S. Dollar as a global reserve currency.
As a result, I am significantly increasing my allocation to gold right now.
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