South Korea is home to one of the world’s most unique and promising economies, thriving off of its status as a tech leader as well as proximity and strong relationships with many of Asia’s rapidly-expanding emerging markets. But constantly looming over South Korea is the unstable relationship with its neighbor to the north, one of the world’s most closed and volatile regimes in North Korea. Tensions have been running high between the two countries for much of this year, as the North expanded its uranium enrichment plan and sunk a South Korean boat earlier in the summer. For its part, South Korea held its annual military exercise despite protests from the North, who viewed this action as a preparation for an eventual invasion. It appears that since South Korea refused to stop the exercise North Korea decided to escalate the situation to a completely new level.
Early Tuesday, North Korea fired hundreds of artillery shells into South Korea, killing two soldiers and injuring many more. South Korea immediately struck back with howitzers and scrambled F-16 fighter jets to deter further action by the rogue regime. Further, South Korean President Lee Myung-bak has instructed the military to strike North Korea’s missile base near its coastal artillery base if it shows signs of further aggression. “The firing of artillery by North Korea on Yeonpyeong Island constitutes an indisputable armed provocation against the Republic of Korea,” President Lee’s top aide for public relations Hong Sang-pyo said in an official statement following an emergency security meeting presided by Lee. “Making matters worse, it even indiscriminately fired against civilians. Such actions will never be tolerated.”
The bold move by the North represents the first time that South Korean soil has been shelled by their communist neighbors since the end of the Korean War in the mid 1950’s. The gravity of the situation helped to sink the Korean won by more than 2.5% in early trading on Tuesday and led to a wide sell-off in other Asian currencies as well. “The incident prompted investors to close dollar short-positions against all currencies,” said Jeong My-Young an FX Strategist for Samsung Futures.”This kind of incident can trigger automatic stop-loss selling of non-dollar currencies. That may put pressure on emerging Asian currencies, which have enjoyed strong gains so far this year.”
This news also dragged down equities across the world, which were already suffering from low levels of investor confidence thanks to debt concerns in Europe and fears over a Chinese rate hike. Not surprisingly, Tuesday’s events had an especially devastating impact on ETFs tracking the South Korean stock market. “This is a trigger for the ‘risk off’ button. You’ll certainly see selling in risk-based markets like equities and commodities until we get a better read on events,” said Mark Pervan, senior commodities analyst at ANZ in Melbourne. “There should be reasonable support for gold although we often see a firmer dollar as the initial reaction to risk and lower gold prices, but industrial metals might get hit. Oil too.” Below, we profile the two main ETFs tracking the South Korean economy, both of which have been battered in Tuesday trading:
iShares MSCI South Korea Index Fund (EWY)
EWY, the most popular South Korean ETF, saw its value tumble by over 5.5% in mid-morning trading on the news of conflict beterrn North and South. The fund also reached its daily average volume by 11 AM eastern time, suggesting a period of extremely heavy trading. Among the fund’s top holdings are Samsung Electronics (15.8%), steel producer Posco (PKX) (6.3%) and Hyundai Motor (4.4%). While these companies could benefit from a lower won if the tensions do not escalate any further, the thought of a prolonged military conflict has clearly spooked investors.
IQ South Korea Small Cap ETF (SKOR)
For investors seeking more of a ‘pure play’ on the South Korean economy, SKOR offers another way to access the country’s equity market through a U.S.-listed ETF. The fund tracks the IQ South Korea Small Cap Index, a market cap-weighted benchmark that includes the small capitalization sector of publicly traded companies domiciled and primarily listed on an exchange in South Korea. Much like its large cap focused counterpart, this fund plummeted on news of the attack. However, the greater volatility of small cap securities ended up hurting holders of SKOR today as the fund is down over 6.6% in Tuesday’s trading session.
In addition to these two main ETFs, three funds have more than one-fourth of their assets in South Korean companies [see all the ETFs that offer exposure to South Korea here]:
- PowerShares FTSE RAFI Asia Pacific ex-Japan Portfolio (PAF): This ETF allocated almost 35% of its assets to South Korea; the fund is down 3.8% today.
- iShares S&P Asia 50 Fund (AIA): This ETF allocates about 27% of the assets towards Korean companies; the fund is down 3.4% today.
- BICK Index Fund (BICK): This First Trust fund allocates about 25% of its assets to South Korea, the fund is down 3.5% today.
Disclosure: No positions at time of writing.
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