The word "that" is used to refer to a concept--in this case, it feels like it would actually refer to "strategic proximity".

"I love him." That is what I said. That refers to the phrase. I can't say for sure that it is ALWAYS this way, but generally that replaces a phrase or a concept, not an object.
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Affording strategic proximity to the Strait of Gibraltar, Morocco was also of interest to the French throughout the first half of the twentieth century because they assumed that if they did not hold it, their grip on Algeria was always insecure.

D : ........Because French (THEY) assumed THAT.......... without THAT......... ( Does this sent at all makes sense?),

Thus not a genralisation but contextually THAT here simply doesn't work ..................... and IT comes into the picture to refer back to Morocco.

1.(used to indicate a person, thing, idea, state, event, time, remark, etc., as pointed out or present, mentioned before, supposed to be understood, or by way of emphasis): That is her mother. After that we saw each other.
2.(used to indicate one of two or more persons, things, etc., already mentioned, referring to the one more remote in place, time, or thought; opposed to this ): This is my sister and that's my cousin.

those things are incorrect on gmat. sory

on gmat, "this"/"that" is never used as stand alone pronoun. Ron said.

there pronouns are used in paralel strucuture to refer to a noun in previous phrase. the noun refered is different from the noun in previous phrase

my spirit to learn gmat is good, and that of my friend is good aslo.

"that" refers to "spirit of my friend" which is different from the spirit of mine

on the other hand, "it" pronoun is different. "it" refer to the same thing which appear in the previous phrase

my spirit to learn gmat is good; it is high

"it" refers to total "my spirit to learn gmat"
we can not say
my spirit to learn gmat is good; that is high
above sentend is wrong on gmat though correct in general English.

come back to the problem
Affording strategic proximity to the Strait of Gibraltar, Morocco was also of interest to the French throughout the first half of the twentieth century because they assumed that// if they did not hold it, their grip on Algeria was always insecure.//
(A) if they did not hold it, their grip on Algeria was always insecure
(B) without it their grip on Algeria would never be secure
(C) their grip on Algeria was not ever secure if they did not hold it
(D) without that, they could never be secure about their grip on Algeria
(E) never would their grip on Algeria be secure if they did not hold it

this is great question.
according to above analysis, "that" in D is wrong.
in E, inverted "would" is wrong. there is no this structure on general grammar.

the problem I doubt is about A and C

because the authou assumed, we need hypathetical sentence "if did, would do" . there is no "would" in A and C. Wrong.

the pattern in A and C dose exist but is used to say about past observation, which is not the case in the question. for example,

if in the past, any one passed gmat, he/she get hight scholarship

this is correct sentence but this pattern is wrong in the posted problem

pls, comment/supplement/modify the above thinking. Thank you