The U.S. Proxy War With Russia
A point I made last month, that the Ukraine War is a proxy war between the U.S. and Russia. Now that the U.S. House of Representatives has passed an enormous, $40 billion in aid for Ukraine, more observers are acknowledging that this is a proxy war.
As dangerous as it is to have one proxy war between two nuclear superpowers, there's a possibility we may end up with a second one, between the U.S. and China. More on that below, but first let's consider the big picture, geopolitically. Finally, we'll look at an investing approach in light of all this.
The Big Picture: China Is America's Main Geopolitical Competitor
Russia may have the largest nuclear arsenal in the world, and its economy may be larger and more resilient than the West assumed when levying their sanctions on it,
But Russia is not America's main geopolitical competitor. That title clearly belongs to China, which has ten times Russia's GDP and ten times its population. Some have speculated that China is the ultimate "audience" for the West's proxy war against Russia, to show the power of the West's sanctions and military aid that could be brought to bear against China in a proxy war against it.
The Risk of a Proxy War with China
In a post last Sunday (That '70s Show), I wrote that we had the inflation and bear market of the early '70s, but instead of that period's Détente with Russia and China, the United States State Department was poking the Chinese dragon over Taiwan.
Now ZeroHedge has shared a post by Mathew Ehret warning that Taiwan might end up being the "Ukraine of the Pacific":
Biden himself has pledged that Taiwan can “count on America’s support” were an invasion to break out at any time. These supportive words were backed up with a $750 million deal to provide a Howitzer military system to Taiwan in August 2021, a $100 million deal to supply and upgrade Taiwan’s patriot missile systems on February 8, 2022 and another $95 million missile deal on April 6, 2022. After the second of these three deals, the Taiwanese foreign ministry sounded like it was trying to out-Zelensky Zelensky saying:
“In the face of China’s continued military expansion and provocative actions, our country will maintain its national security with a solid defence, and continue to deepen the close security partnership between Taiwan and the United States.”
China’s concerns over the vast expansion of US efforts to turn Taiwan into a Pacific Ukraine (including a doubling of military officials in the US embassy compound in the past year) are very real.
Ehret is not the only observer with these concerns; in the interview below, John Lander, former Australian ambassador to Iran and deputy ambassador to China, warns of the risk of the West fomenting a proxy war over Taiwan--and, failing that--using Australia as a proxy instead.
For those pressed for time, Arnaud Bertrand highlights two key segments of the interview below.
Investment Considerations
Our general approach is to buy a handful of names we estimate are likely to do well over the next six months, and hedge in the event we end up being wrong. Lately, the types of names our system has estimated are likely to do well over the next several months have been limited mainly to commodities and bearish ETFs. Presumably, a proxy war with China would increase the inflationary pressures of the current proxy war with Russia, further boosting commodities names, but our system will continue to gauge stock and options market sentiment to select securities, rather than making top-down macro bets.
Our Approach In Action
Here's an example from six months ago to show our approach in action. It's a particularly useful example in that it includes a couple of names we got right, The United States Natural Gas ETF (UNG) and the ProShares Ultra Bloomberg Natural Gas ETF (BOIL), and one we got very wrong, the bitcoin miner Marathon Digital Holdings, Inc. (MARA).
This was the hedged portfolio our system presented for investors last November who had $30,000 to invest but were unwilling to risk a decline of more than 13% over the next six months.
Screen capture via Portfolio Armor on 11/11/2022.
Our system started out by allocating equal dollar amounts to BOIL and MARA and then it rounded down those dollar amounts to get round lots of each name, to lower hedging costs. Then it used a tightly collared UNG position to absorb most of the leftover cash from the rounding-down process.
Over the next six months, the natural gas ETFs did well, but the bitcoin miner MARA dropped 86%.
Here's how the hedged portfolio did as a whole:
Overall, the portfolio was up 8.6% over the next six months, net of trading and hedging cost, while the SPDR S&P 500 Trust ETF (SPY) was down 14.75% over the same period.
You can view an interactive version of that chart here; if you slide your cursor all the way to the left, you'll see underlying security value of MARA was $7,069 on November 11th, versus $998 shown above on May 11th. That's the 86% drop. But the net position value, including the hedge, was down only 11% over the same time frame.
Something to consider given today's elevated geopolitical risk.
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