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North Korea And Commodities In 2018 – Seeking Alpha

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Geopolitical events have a habit of influencing prices in markets across all asset classes. These days, perhaps the most dangerous and possibly incendiary situation facing the world is on the Korean Peninsula.

The Korean conflict ended in 1953, and while the sides signed an armistice, no peace treaty followed and technically both North and South Korea are still at war, with the United States supporting the South, and China the North. In 2017, North Korea became a nuclear power with weapons that could potentially reach all of the United States as well as the rest of the world. Over recent months, rhetoric between the U.S. and North Korean governments have increased, and tension continues to build. The United Nations have imposed sanctions on the hermit nation, which they have ignored. China has leaned on the North Korean leadership, but Kim Jong Un has stood firm, thus far. President Trump has repeatedly said that while war is a final option, a nuclear North Korea is not acceptable and the U.S. will not accept anything other than denuclearization. The North Koreans have responded, no dice.

The latest missile test came in late November after a two-month lull. However, the rocket flew higher than in previous tests meaning the range now threatens all of the United States. President Trump’s response was, “we will handle it.” The situation between North Korea, the rest of Asia, and the United States is likely to come to a head in coming months and it could impact commodities’ prices across all sectors.

North Korea is not a significant producer nor is it a major consumer

North Korea with a population of 25.4 million people is not a significant producer or consumer in the commodities markets. With only slightly more people than Australia, and less than Madagascar, the potential for the nation as a consumption center in the future is limited. South Korea is double its size when it comes to inhabitants. However, North Korea has one thing in common with Australia; it is a mineral-rich country. Despite years of isolation from the world, the hermit nation has reserves of minerals and metals as well as the potential to produce agricultural products and other foodstuffs.

Over the past six-plus decades, North Korea has spent most of its money on its military and recently has attained nuclear status. After a series of missile tests, the most recent launch proved that all of the United States is within range of the hermit nation. A nuclear-powered North Korea is a danger to the U.S. and many countries around the world. Rhetoric between the U.S. and North Koreans has been rising steadily over recent months. While the U.S. has said it does not seek regime change, President Trump continues to demand denuclearization. Meanwhile, the North Koreans have continued to test-fire missiles and provoke the world’s leading nuclear power. The tension between the two nations is reaching a boiling point, and the potential for hostilities have not been this high since 1953 when the Korean conflict ended without a peace treaty.

A nuclear-armed North Korea is unacceptable to the U.S., South Korea, Japan, and many other nations around the world. So far, the North Korean response to demands that they stand down has been, no dice.

War in the region will impact logistics

If war were to break out on the Korean Peninsula, it would likely cause logistical problems when it comes to shipping raw materials around the world. China is the demand side of the equation when it comes to commodities, and the nation with 1.4 billion people shares a border with North Korea. Over recent months, China has been a significant buyer of metals, minerals, and crude oil which lifted prices. Many analysts have attributed Chinese demand to President Xi’s plans for China’s economy. In the recent party congress that took place in late October, the Chinese President outlined his plans for coming years. President Xi told party members he would cut pollution in major cities, increase the size of the country’s middle class, and build a “world-class military” by 2050. All of these initiatives will require more raw materials than China produces within its borders and the Asian nation has been buying and increasing their stockpiles.

Chinese stockpiling could be preparation for hostilities

While China is the demand side of the fundamental equation in most commodities markets, the recent wave of buying could be, at least in part, the result of increasing tensions and the rising potential of war on the Korean Peninsula. A conflict with a heavily armed and nuclear-powered North Korea would claim many lives and could lead to catastrophic results for the world. It would also increase the risks associated with shipping cargos of raw materials in Asia. On Wednesday, December 5, the Baltic Dry Index was trading at 1666. Source: BDIY Quote – Baltic Dry Index

The Baltic Dry Index is a benchmark for the cost of shipping dry bulk commodities around the world. As the chart highlights, the BDI is trading at its highest level in almost three years and could be a sign that the risk of shipping has increased. At the same time, Chinese raw material buying over recent months has lifted the prices of some commodities and the level of freight rates as they take delivery.

If the war of words between North Korea and their enemies in South Korea, Japan, and the United States leads to hostilities, the prices of commodities could become highly volatile because of the geopolitical ramifications.

If the North Korean regime falls, the Chinese and
South Korean models mean increasing demand

While a war with North Korea would likely have tragic consequences when it comes to the loss of life, the current regime would fall. Kim Jong Un is playing a high-stakes game with his growing nuclear arsenal and is betting that the U.S. ultimately will back down. The family dynasty, starting with his grandfather, has put the country on a course of strength through weaponry and threats for its survival. While the standard of living in North Korea is among the lowest in the world, the nation has spent all of its money on defensive and offensive weaponry. The hermit nation now possesses expensive weapons of mass destruction.

As the standoff comes closer to a boiling point each day, if the regime eventually falls, it is likely that North Koreans will quickly follow the models in the South and China. While only a nation of 25.4 million, any rise in the standard of living will result in dramatic increases in commodities consumption. At the same time, it is probable that Chinese and other Asian nations will flood into a liberated North Korea to exploit the workforce and the mineral-rich geology of the country.

I believe that the ultimate solution for the North Korean problem is that China needs to make the regime an offer it cannot refuse. Allowing Kim Jong Un and his family, and closest supporters to keep their wealth and live their lives in luxury in exile would open the door for China to make the country another province with a productive labor force and plenty of available commodities. I further believe that this solution would be acceptable to the United States and the world as the current DMZ would change from a dangerous border to an area of trade and cooperation. The higher tensions rise in the region, the more attractive this solution becomes. The Chinese worry about a flood of refugees across the border and Freedom Bridge if war were to break out. A peaceful solution that allows China to take the nation under its nuclear umbrella will keep the borders secure and allow Chinese exploitation and an expansion of their sphere of influence.

Status quo increases world tension

Meanwhile, as we head into 2018, a nuclear-armed North Korea remains one of the most significant problems in the world. A war would be a tragedy, and a nuclear strike a catastrophe. However, with each missile test, the world comes closer to hostilities. It is probable that some of the motivation for Chinese stockpiling of commodities over the second half of 2017 was the result of concerns over the problems that face the Korean Peninsula. The status quo in the standoff between the North and South, with missiles flying over Japan and barbs exchanged with the U.S. President, will continue to present the world with a rising environment of fear and uncertainty.

North Korea has shown no sign of backing down. After a two-month lull in missile tests, they fired their newest and longest-range missile in November. The U.S. responded with military exercises in the region. China will need to become involved and inventive to protect their interests in the area. While stockpiling of commodities in 2017 could offset the short-term effects of hostilities on logistics in the region, China knows that war is not a solution that is in their best interest. I expect this issue to come to a head in 2018 and believe that, like Vito Corleone, they will make Kim Jong Un an offer he cannot refuse. Until then, expect this geopolitical issue to continue to dominate the news cycle and cause volatility in markets across all asset classes until there is a resolution.

When it comes to commodities, a liberated North Korea will join the rest of the world, and living standards will rise causing demand for raw materials to grow. At the same time, the exploitation of their geology and fertile soil will increase the supply side of the equation for many of the commodities in the crust of the earth in North Korea. With all of the money spent on military pursuits, the hermit nation has not scratched the surface when it comes to the potential for commodities output in their country.

Each week in The Hecht Commodities Report, I provide subscribers with up, down, or neutral price bias based on a combination of fundamental and technical analysis. The report is a useful ready reference for investors who trade or invest in futures and options markets, in ETF and ETN products, as well as all asset markets.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The author always has positions in commodities markets in futures, options, ETF/ETN products, and commodity equities. These long and short positions tend to change on an intraday basis.