In the wake of the latest military incident in the South China Sea, I’d like to reassert an investment opportunity sitting atop my watch list.
First, let me get you caught up on what’s happening.
Last week, the U.S. Defense Department acknowledged a close call between an American naval jet and a Chinese surveillance aircraft.
Press wires report that the two planes got within a thousand feet of each other.
The incident happened above the hotly contested Scarborough Shoal in the South China Sea.
If you’re wondering why the South China Sea suddenly lies at the epicenter of controversy, there are three contributing factors:
Factor #1: China claims virtually all rights to the South China Sea, including a vast channel of tiny islands — islands that stretch as far as 800 miles from the Chinese mainland.
Factor #2: The Philippines, Malaysia, Brunei and Vietnam contest China’s rights to those islands.
Factor #3: China is expanding its territory by pouring cement onto coral reefs in the South China Sea and turning them into military bases.
The latter factor has the United States military totally unnerved.
Seeing is believing…
Take a look at the image below of dredging ships building up a reef with concrete (courtesy of The New York Times).
The United States has deployed a fleet of underwater drones to conduct reconnaissance missions in the South China Sea.
You’ll recall that China recently captured one such drone.
Since the situation is getting extremely volatile, I asked my senior analyst, Martin Hutchinson, to do a deeper dive.
It’s truly shocking.
Click below for Hutchinson’s full report.
Chief Investment Strategist, Wall Street Daily
Question: Yesterday, Martin handicapped the odds of a market crash. But today, he’s discussing something potentially even bigger. That is, the increased military activity in the South China Sea. With so much activity of late, I thought it would be prudent to understand the situation better and how it may impact our investment decisions.
Martin, why has there been such a military buildup?
Martin Hutchinson: It’s been going on for quite a long time. China has fortified the first island chain, which is a huge chain of islands that stretches right down from Japan, past Taiwan and the Philippines to the Straits of Malacca. And China’s been taking reefs on that chain — in other words, bits of rock that are covered at high tide — and building them up. It’s pouring concrete on them, until they go above the tide line and so effectively become extra islands.
Once they’ve done that, you can put military installations on them — which China has. But you can also declare a 200-mile zone round them. In which you’ve got the drilling rights, and you can interdict other countries’ shipping if you want to.
China has been doing that very aggressively — asserting its rights in the offshore China Sea.
Question: So they’re in effect expanding their territory. It’s so interesting. But what’s changed recently?
Martin Hutchinson: They’ve got more aggressive about it. I mean, China seized a U.S. naval drone in December. The aircraft carrier Liaoning is now patrolling the western Pacific beyond that chain of islands. In other words, they effectively expanded their zone of naval patrol right out into the Pacific.
China’s aggression in this area has galvanized the neighbors… Japan is fortifying the Ryukyu Islands. And the U.N. tribunal recommended that the Philippines have the rights to a part of the first island chain near the Philippines. But it’s not done them any good.
Fortunately, President Duterte of the Philippines appears to be trying to make nice with China at the moment — I think because he thought the U.S. wasn’t a reliable ally under President Obama. Of course, now he’s got President Trump, so he may be happier — and that may not happen.
The most important thing that’s happened recently is that the new secretary of state, Rex Tillerson, has said that the U.S. will deny China access to its bases that it’s built on these reefs.
Question: So, Martin, what is the likelihood that this powder keg is going to blow?
Martin Hutchinson: I think, regrettably, quite high. Of course, an aggressive policy gets Xi Jinping’s support in China. The Chinese economy is not doing as well as it has been these days. So he needs to bolster his support. Like in any country, a bit of local aggression always cheers up the populace. He’s got that, and he’s warned of a large-scale war if the U.S. does anything in these islands.
We have to remember that China is a much more important adversary than Russia. Everybody goes on about President Putin and what Russia might do. But Russia is economically a pipsqueak. It has GDP of only $2 trillion.
China is $12 trillion, and the U.S. is $19 trillion. So China is really big enough to challenge the U.S. if it wants to. The U.S. has been looking at options regarding what to do with this.
Question: Give it to us, please, Martin. Bottom line it for me. What’s likely to happen next?
Martin Hutchinson: The U.S. has looked at a number of options. One is to blockade these reefs. In other words, stop Chinese shipping from getting there. Another is to blow up the Chinese installations on the reefs. Another is to mine the South China Sea so the Chinese can’t use it to get to the reefs. And the other thing they could do is use their naval artillery to attack Chinese vessels.
All of those are pretty aggressive, and China has said that there could be a large-scale war. I think it’s something that we need to be very carefully watching.
Question: This is a situation that we’re monitoring closely, Martin. If news breaks or the situation changes, will you report back?
Martin Hutchinson: Very much so. Absolutely.
Senior Analyst, Wall Street Daily