How To Invest In North Korean Denuclearization

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Includes: EWY, KB, PKX, SHG, WF
by: Ivan Martchev
Summary

North Korea does not have a stock market and investing in denuclearization, which I think is coming, can only be done via surrogates – like China or South Korea.

China is problematic as an investment surrogate for North Korea, as it's too big for one to be able to find a leveraged investment on North Korea.

South Korea is a better investment surrogate.

By the time you read this, Kim Jong Un’s armored train would have arrived in Hanoi, Vietnam for the second summit between the United States and North Korea. This is important as the seeds have been sewn for the opening of North Korea and the commencement of a new investment cycle in the hermit state that promises to bring long overdue peace to the Korean peninsula.

Credit needs to be given to President Trump for negotiating directly with Kim Jong Un, as previous Democratic and Republican presidents have been unwilling to engage the North Koreans in such a direct way before. It is true that the North Koreans have reneged on numerous deals before – stimulating such unwillingness – and that they may renege yet again, but only an unconventional leader like Donald Trump could pull off a trade deal with China and sign a peace treaty ending the Korean War in the same week!

I believe that Kim Jong Un is very different than his father, Kim Jong-Il, or his grandfather, Kim Il-Sung, who set up the communist state. “Little Kim” was educated in Switzerland and has seen the ways of the Western world in his formative years. I believe he understands that he needs to make substantial changes in order to survive and cling to power for as long as his father and grandfather did before him.

His half-brother, who was assassinated in Kuala Lumpur in 2017 did not think that little Kim was up to the task. Yoji Gomi, the Japanese journalist and author of “My Father, Kim Jong Il, and Me,” said of the assassinated Kim Jong Nam at the time of the launch of the book: “He (Kim Jong Nam) sees his brother failing. He thinks he (Kim Jong Un) has a lack of experience, he's too young, and he didn't have enough time to be groomed. Those three reasons are why he thinks he'll fail.” (see CNN.com 1-17-2012)

Little Kim has not failed yet and based on what he has done with the North Korean economy so far, he is hell-bent on succeeding. In addition to the gruesome consolidating power, including the execution of his own uncle with anti-aircraft machine guns (see New York Times,March 12, 2016 “In Hail of Bullets and Fire, North Korea Killed Official Who Wanted Reform”), little Kim has begun a number of economic reforms that resulted in rising economic growth in North Korea (before recent sanctions began to bite).

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Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Economic growth in 2016 was the highest since 1999, due to liberalization of the economy – with small merchants allowed to go into business for themselves and factory managers given more autonomy to run their enterprises. Still, the fact remains that North Korea does not have a stock market and investing in denuclearization, which I think is coming, can only be done via surrogates – like China or South Korea.

Investment Surrogates Are Not Created Equal

China is problematic as an investment surrogate for North Korea, as it's too big for one to be able to find a leveraged investment on North Korea. I think the Chinese will be very active if North Korea opens up, as China is their #1 trading partner at the moment, with three quarters of all North Korean trade being done with China. China needs to maintain their influence there and will remain a major investor in the country.

Since I believe that China has very serious economic problems of its own – namely, an epic credit bubble that is likely to sooner or later put them in a bad recession, even with a trade deal – they are not likely to be a good proxy to be used as a North Korean investment surrogate, in my view.

chart3.png

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

South Korea is a better investment surrogate. Still, 24.8% of South Korean exports go to China and 20.5% of South Korean imports come from China, making China the largest South Korean trading partner. This is part of the clever Chinese scheme that the Trump trade deal is trying to attack, wherein the Chinese purposefully buy more from countries around them in order for them to increase their political influence. That way, even with a large U.S. military presence, China still gets more leverage. This is the primary reason why the Chinese cannot close the trade gap with the U.S. very quickly, as they will have to redirect their state buyers to buy more from the U.S., but if they do such a maneuver too quickly, it will create unintended political consequences with many regional countries, which they had previously favored.

The easiest proxy for North Korean liberalization is to buy the South Korean iShare (NYSEARCA:EWY) as North Korea is big enough to create economic leverage for South Korea. Population in the North is 25.5 million while South Korea’s population is 51.4 million, inviting easy parallels with the reunification of East and West Germany, which were of similar size, and similar prosperity gaps. The trouble is, I do not believe that anyone in North Korea wishes to be absorbed by the South – and neither do the Chinese.

For more leveraged plays, investors could research South Korean financial ADRs like KB Financial (NYSE:KB), Woori Bank (NYSE:WF), and Shinhan Financial Group (NYSE:SHG), which should be major beneficiaries of an investment cycle in North Korea. If I were not bearish on China’s near-term economic prospects, I would say that advanced steel producer Posco (NYSE:PKX) would also be a good candidate, but Posco’s leverage to China is too big at a time when the Chinese economy is slowing, so any leverage to North Korea would be a secondary concern for a few years.

(Please note: Ivan Martchev does not currently hold a position in KB, WF, SHG or PKX. Navellier & Associates does not currently own a position in KB, WF, SHG or PKX for any client portfolios).

Disclosure: *Navellier may hold securities in one or more investment strategies offered to its clients.

Disclaimer: Please click here for important disclosures located in the "About" section of the Navellier & Associates profile that accompany this article.

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.