Louis-Vincent Gave, co-founder of Gavekal Research, has been warning investors about a paradigm shift in the world order. Specifically, Gave says the assumptions underpinning financial assets need to be rethought due to a move toward a multipolar world and away from one dominated by the U.S. and the dollar. His message seems especially germane now, given Russia’s invasion of Ukraine, the West’s dramatic sanctions, and China’s attempts to support Russia without jeopardizing its economic ties with the West.
Gave, who served in the French army and studied Mandarin at China’s Nanjing University during his undergraduate days at Duke University, co-founded the Hong Kong–based independent macro research firm in 2000, with a focus on Asia. His seventh book, Avoiding the Punch: Investing in Uncertain Times, published last year, provides a framework for helping investors to navigate a period of geopolitical competition, high stock market valuations, and low interest rates.
Gave recently spoke with Barron’s from his office on Canada’s Vancouver Island about why China could emerge as a relative winner from the war in Ukraine. He also explained why long-held assumptions about globalization and the dollar’s dominance need to be reassessed, and why it isn’t yet time to buy stocks, even after their correction. An edited version of the conversation follows.
Barron’s: What is the likely fallout for investors from Russia’s invasion of Ukraine?
Louis-Vincent Gave: We have two crises. The sanctions on Russia have turned an already precarious energy situation into a full-blown crisis. From there, we’re going to have a problem with food costs, which will lead to riots, political uncertainty, and the rise of populist parties in democracies. And we have an unfolding financial crisis. Financial markets are based on trust and everybody playing by the same set of rules. In war, trust collapses and rules change quickly.
The big question is whether the Western world blocking Russia’s foreign reserves and saying, “You thought this money was yours; turns out it isn’t,” acts as an accelerant for a change in the global financial architecture such as we have known it in the post–Bretton Woods era—where all trades are dominated in U.S. dollars, and foreigners earn U.S. dollars and recycle those into U.S. Treasuries, allowing the U.S. to run very large twin deficits with no constraints.
Let’s take energy first. What do soaring prices mean for investors?
China is the big winner. In September, China’s leadership said we are entering an energy crisis and reopened coal mines. Coal is the cheapest way to produce electricity, and the guy with the cheapest cost of electricity typically wins [economically]. From 2000 to 2011-12, that guy was China. Starting in 2012, pollution led the Chinese to [reduce the production of coal].
The mantle of the cheapest energy producer then moved to the U.S. due to the shale revolution. Now, the mantle is moving back to China, which not only has coal but also is going to become one of the only outlets for Russian energy. And better yet, for the Chinese, Russian energy is going to settle in renminbi or gold, not dollars.
Why is that so important?
For years, China had to earn U.S. dollars first to buy energy. The Chinese stockpiled dollars. Now, they don’t need to do that because they are producing domestic coal—priced in renminbi—and they can buy energy from Russia, priced in renminbi that they can just print. In essence, their energy cost is almost free. If China doesn’t need U.S. dollars, does it care about having a positive trade balance with the U.S. through which to generate excess dollars? It doesn’t, so the renminbi could go much higher.
What role do you see China playing in the war?
Having Russia and the Western world at each other’s throats works well for China because they aren’t occupied [with China]. I don’t see why the Chinese would feel a need to stop this. If the embargo of Russia can last forever, so much the better for them. It also helps them internationalize the renminbi. Once China buys all of Russia’s oil and natural gas and coal in renminbi, it is going to turn to the United Arab Emirates and Saudi Arabia and say, “We like your oil so much better than Russia’s. If only you took renminbi, we could do more business.” If you are Saudi Arabia and your biggest client would like to do more business, you have to at least think about it. This is playing into China’s hand.
You have said that you see another financial crisis brewing. Where, and why?
Financial markets need common rules that won’t change, and trust. Today, nobody has a clear vision of European banks’ exposure to Russia—direct or indirect. Banks are hemorrhaging trust and money. You can see this in the blowout in [European] credit default spreads and widening in bond spreads [versus German government bonds]. Also, Europe risks a massive energy shortage, and there’s growing political uncertainty.
How do you see this potential crisis playing out?
Europe’s economic growth will collapse. Over the next six months, inflation that continues to rise will lead to popular discontent. In the fall, Europe may see a massive surge in immigration, similar to the one that followed the Arab Spring, as the surge in wheat prices will create further political instability in the southern and eastern sides of the Mediterranean. Rising inflation plus surging immigration will boost the vote of the populist parties, which will be visible in the Spanish and Italian elections in 2023. While clouds hang over Europe, I wouldn’t be inclined to add risk. You need to see the European situation stabilized.
Where should investors hide?
The first building blocks [of an investment portfolio] are antifragile assets that can thrive when the world falls apart. Pre-Covid, the ultimate anti-fragile asset was U.S. Treasuries. Each time U.S. equities fell 5% or more, [a Treasury holder] made money because yields fell and prices rose. In the past two years, there were five different periods in which the S&P 500 index lost 5% or more. [Owners of] Treasuries lost money in each of those periods.
What’s “antifragile” today?
There are three. Chinese government bonds are one, but they aren’t available to everyone. Gold is another, but it sometimes doesn’t perform. It is rising now because one of the big risks is [the possibility of] a change in the post–Bretton Woods environment. If the world is no longer happy trading U.S. dollars and accumulating U.S. Treasuries, gold benefits.
The third is energy. When you see the bull market dead on the floor with a knife in its back, you round up the usual suspects: too high a cost of capital or too high a cost of energy. Central banks have made it clear they aren’t going to let the cost of capital rise that much, so the big risk is energy.
What goes in the “safe” bucket?
Investors could also seek shelter in U.S. consumer-staples stocks, some healthcare stocks that have struggled, and the Chinese infrastructure companies that have been crushed. If you have to own bonds, you want Treasury inflation-protected securities, or TIPS. But there are better options: Chinese government bonds have outperformed everything else on a one-, three-, five-, and 10-year basis. [Two ways for retail investors to access Chinese bonds: The
VanEck China Bond
exchange-traded fund (ticker: CBON) and the
KraneShares Bloomberg China Bond Inclusion Index
How safe are Chinese government bonds when sanctions froze Russia’s foreign reserves and U.S.-China relations are still fraught?
The argument that you can’t invest because your assets might get frozen didn’t exist until two weeks ago, but it is decently strong now. But the only way you wouldn’t be allowed to own a Chinese bond is if China invades Taiwan, which I don’t think it will.
A 60-mile amphibious operation is extremely complicated to pull off with an untested army. If you’re China, you’re looking at Russia and thinking, that seems like a gamble. Russia is also being sanctioned but can take it because it isn’t as integrated into the global economy as China. It would be a gamble [for China], and China’s leaders aren’t gamblers. In crisis moments, they like to maintain the status quo.
What does the changing world order mean for globalization?
The globalization trade that has underpinned almost every portfolio and corporate strategy began to fray with the trade war. It involved not only tech but also energy, commodities, currency. If a U.S. or European company that has outsourced to China sees the sanctions on Russia, they might think, “If China ever invades Taiwan, I can’t have my IT department [there].” Even if sanctions were lifted, who is going to rush back in? The trust is gone.
had to write off $25 billion of investment in Russia. Before BP goes back in, you’ll need at least a couple of CEOs to forget [this].
How does Russia’s invasion of Ukraine affect China’s calculus around Taiwan?
If Russia puts Ukraine to the sword, and the Western world effectively does nothing, China can say to Taiwan, “Ukraine was a sovereign nation. You’re just a renegade province that nobody recognizes. How convinced are you that the U.S. would back you? Come to the negotiating table, and let’s strike a deal.”
Given the selloff in global stocks, is it time to buy?
Financial crises end with central banks flooding the system with liquidity. We haven’t seen that yet. We have an unfolding energy crisis, which usually ends with a recession. So, no, I’m not rushing to buy.
Write to Reshma Kapadia at firstname.lastname@example.org