Last week I was asked over lunch what I thought was the single biggest risk for investors. Fiddling with my slightly overchewy steak I debated whether to mutter the usual dread words (inflation, equities sell off) before deciding on Taiwan and late 2024.

I had thought about zeroing in on rising real rates but I’m not convinced that bond yields and interest rates will rise by enough to trigger the real rates crisis. As I’ve mentioned more than a few times I think inflation rates will begin to ease in Q1 or Q2 next year as some of the current pressure points ease. In fact I would go further and argue that we have not yet completely banished the threat of deflation in the US and Europe, which I think could re-emerge sooner than we think. But my sense is that the UK will remain an island of higher inflation with our rates trending above the usual 2 to 3% range, possibly even stuck between 3 and 5%. For real rates to be a problem we’d have to believe that interest rates would rise above 2 to 3% and 10 year government bond yields move above 3 to 5%. I think that unlikely though not impossible. So real rates remain an outlier concern as does stagflation and hyper inflation concerns.

I do have a concern that we could have a regime shift in central bank policy as the era of austerity ends and we head into a period of pronounced fiscal expansion by more populist governments. This could prompt central bankers to massively rein back in their easy money policies, prompting more taper tantrums. That said, I’m not completely convinced of this scenario either though it is more likely than the spectre of real rates. My caution is based on a simple logic – central bankers independence has been irreparably compromised and they have been sucked into a set of political judgements that have far reaching implications.

My sense is that a weak form of social justice thinking has penetrated the thought leaders in central banking. This is articulated in green transition discussions as well as explicit unemployment rate targeting. In a sense the central bank elite have simply given in to a wider investment elite that has been infected with the same strand of moral, ESG influenced thinking – that inequality is the central pressing issue of our time and that many policies must be re-adjusted to allow for their uneven distributional outcomes. I make no comment on this, except the obvious point that although some of this thinking is sensible and much needed it has inevitable policy consequences which could be detrimental to building long term investment returns.

So, bottom line – central bankers will always be keen to fight any market volatility because of their concern about unintended consequences for inequality.

All of which leaves the elephant in the room. Taiwan. I don’t think we will see China make a move on the island imminently and my sense is that President Xi might try and dial down tensions in the run up to the big events in 2022 on the mainland.

But Xi has nailed his colours to the nationalist mast and made Taiwan one of THE defining measures of his presidency. I’ve been wading through many military papers on the Taiwan invasion scenario and I’m more and more convinced they’ll try their best to avoid a full on amphibious assault. Instead we’ll see the rise of little green men wandering around causing problems. There will be cyber assaults, and lots of grey zone hybrid military activity. There might then be some form of blockade or embargo and an attempt to strangle the economy.

The pint of pressure will be on Taiwanese will power. In effect all these policies will be designed to test their resilience in the face of increasing volatility and societal turbulence. I would hope that the great mass of Taiwanese citizens react by supporting greater resilience and fortitude but I wouldn’t entirely bet on it. The cynic in me says that someone – a political figure – may emerge who will suggest a more ‘accommodative’ approach. And at that point all bets are off.

I would also suggest that the chances of the US military stopping said turbulence is close to zero. The US needs to consider whether it really has the ability to deter this kind of hybrid warfare and given the lamentable results of the anti Russian policy to date I think the answer is a big fat no.

Which means China might well succeed. But the cost will be a formal bifurcation of the economic system as the West relies on its tried and tested economic sanctions platform. Investments in China will be burned beyond belief and we’ll face a binary economic divide – the Western bloc and the Chinese bloc.

The ripple effects of this on the international monetary and trade order will be cataclysmic. I also mentioned 2024 as my risk date. My sense is that Trump will try again to recapture the Presidency and the Republican party will throw everything it has at that attempt. I also think Biden and Harris are in real trouble. Those border scenes are simply cataclysmic for independent and liberal conservative voters and I don’t see any easy way out of the mess the Biden presidency has landed itself in. So, that makes the chances of Trump winning the vote or at least getting really damned close, very high. Tension around any handover in late 2024 will be heightened. And if I were China I’d make my move then.

So, protect your portfolio against the one obvious risk- which is a China shakedown on Taiwan late 2024. Start dusting off those Ex China funds quickly but also think through the second and third order effects.

Bitcoin vs. Ethereum: “Digital Gold” vs. “Digital Silver” ?

Deutsche Bank released a great note on the crypto space last week entitled Future Payments: Bitcoin vs Ethereum. The central concept of the research is to draw a comparison between tow pairs : Bitcoin/Ethereum and Gold/Silver.

“Ethereum is big and significantly different than Bitcoin. Both have room to coexist. Think about Bitcoin as “digital gold” and Ethereum as “digital silver.” Silver is cheaper than gold, because there is more supply, but it is still a rare precious metal with an industrial use.”

I’d highlight the following observations:

• “Looking specifically at Bitcoin and Ethereum from 2015 to 2021, the correlation between the two cryptocurrencies is strongly positive (90%). In short, there is an 90% chance that a rise in Bitcoin value would lead to an increase in Ethereum’s value, and vice versa.
• Looking at the liquidity of gold and various other commodities in comparison to Bitcoin, it is fair to say that Bitcoin is an illiquid asset
• there is little evidence of a direct correlation between the prices of gold and Bitcoin
• History shows that humans have always had a strong desire to hold an asset that feels separate from the daily working of governments. Gold has been the primary asset of that kind for a long time. Cryptocurrencies have a chance to become an agreed-upon way for people to safely hold wealth
• Some people will argue that wild price fluctuations limit the possibilities to associate Bitcoin as reliable store of value. But nothing is perfect: Gold showed a similar level of volatility when it was freely traded after the abolition of the Bretton Woods system. With the entrance of large players in the market, liquidity should increase and volatility should (hopefully) decrease.
• Its share of the market is around less than half of Bitcoin’s share, and four times more than the third cryptocurrency.
• The primary purpose of Ethereum is to facilitate and monetize the operation of Ethereum smart contracts and its decentralized application platform. It is not designed as an alternative monetary system, such as Bitcoin”

New energy storage fund

Interesting to see that the stockmarket listed energy storage space is hotting up. Monday brought news that Harmony Energy Income is looking to float on the specialist fund segment of the LSE and is seeking to raise up to £230m through the issue of shares at 100p.  The initial focus will be on battery energy storage systems (BESS) located in the UK, through the acquisition of an initial portfolio.

Here’s the quick take from Numis:

• “Target returns: Once fully invested, the target unlevered NAV total return is 10% pa over the long term. The Company is targeting a 2% yield in 2022, which will increase to 8% pa, payable quarterly.
• “Portfolio: On admission, the company will acquire five battery energy storage ‘shovel ready’ projects with an aggregate storage capacity of 213.5MW, acquired from Harmony Energy Limited. The acquisition project is based on a £750k per MW on acquisition and is expected to increase to a value of £874k per MW once constructed. The initial portfolio has the Tesla Megapack 2-hour duration battery system. …. An additional project totalling 99MW will be acquired following admission, taking the initial portfolio to 312.5MW. The company will also have exclusive rights to acquire a further pipeline of BESS assets with an aggregate capacity of 687.5MW, which are already with Harmony Energy’s control.
• “Fees: Management fees will be 0.9% pa of the lower of NAV or average market cap and 0.8% on amounts exceeding £250m. There will be no other asset management of performance fees payable to the manager.”