Trading the War-Rumored Market

Trading the War-Rumored Market

Part 1  The Clausewitzian Redux

Friends and colleagues have asked me in recent days if the sabre-rattling between North Korea and the United States is worth paying attention to. Some are interested in the possibility of a nuclear exchange while others want to know how to trade the uncertainty that is embedded in the market. First, I do not believe that the current tension will escalate into a full blown nuclear conflict, so the former group can take off their tin-foil hats. I do, however, believe that certain financial markets are shaped by the possibility of war. After all not, war is not illogical. War is, at some level, always an economic response.

Listen to what Umair Haque has to say:

What is war? War is a pattern that defies other patterns. It is an avalanche, not an equation. The pattern of stagnation, rage, hate, demagoguery, war, atrocity. That is what World War II really was. The causes were rooted in a German economy broken by a peace whose price was too high: it simply couldn’t repay Britain what was decided that it owed. The result was mass stagnation, that became rage, which metastasized, in the hands of a demagogue, into hate at scapegoated minorities, and then hurled, blitzkrieg, at neighbors and allies, in the forms of planes and tanks.

War serves certain people and achieves certain goals-particularly when politics and politicians have failed to do anything to deal with stagnation or inequality. Stagnation, scarcity, inquality and shame feed the war machine. The threat of armed nuclear conflict as an interpolation of force into the global power balance is cut from the same Clausewitzian cloth from which all preceding modern wars have been.

War is not for the absence of logic, it is the obliteration of reason. When war is considered it is because politics and today's politicians--have neither logic nor reason at their disposal. We would like to think that statecraft between the likes of Kennedy and Krushev or Churchill and Stalin are far different things than watching two bonified lunatics square off in a war of words that comes down to "whose missile is bigger". 

I leave that bit to the reader to sort out. 

Big nukes

But what about those big nukes.

While most analysts believed that the North Korean nuclear program was an improbable bet, they likely underestimated it. Even though North Korea has regularly overstated its military capabilities, these claims were considered specious by regional military rivals and analysts. Analysts believe that there is now significant evidence that their latest test missile was in fact an ICBM.

Given the flight time and altitude reached, the missile could have a range of more than 6,500km if fired at a standard trajectory, said David Wright, a prominent North Korea missile expert. ICBMs are typically classified as having a range of more than 5,500km. In other words, the North Koreans could, theoretically launch an attack on Anchorage, or Honolulu. This fact alone, is unreasonable and irrational because I assure you that no one, including the North Koreans thinks bombing Alaska or Hawai'i would be a good idea.

...And what about those Quiet Chinese Folk

China will not stay quiet if the peninsula degenerates into conflict. They did not to sit out the Korean war in 1950, and that was less than one year after the founding of Mao’s People’s Republic. Historians believe that China did so to prevent an American victory. Deep anxiety about the possibility of a US military presence on its north-eastern land border has been an abiding concern for Chinese security policy for over half a century. 

China could also act as a negotiator and talk the North Koreans out of their nuclear program through politics and diplomacy; they also might leverage their recent trade disagreements with the US and triangulate one or both countries. Either way, through financial and economic sanctions, real policy change in Pyongyang is not likely. Second, the US could launch a unilateral military attack on North Korean nuclear facilities to destroy or at least degrade the program.  

The US could adjust to the reality of a North Korea armed with nuclear-tipped intercontinental ballistic missiles and seeks to impose sanctions similar to those placed on Iran. I think it is nearly impossible to imagine the Trump administration accepting this idea. In fact, by bludgeoning the N. Korean's regimes resistance, it would send a clear message to Iran about keeping up its end of last July's deal. Trump may be a deal-maker, but he is also a hot-head who has said that nuclear ambitions concern him more than melting ice-caps. 

The Chinese, given their preference for soft power, are willing to let things unfold with the Americans and keep an eye on their neighbor. Idealistically speaking, the Chinese could be waiting for the Americans to  accept North Korea as a bona fide nuclear weapons state which strengthens the local nuclear axis but that is not going to happen. Remember, there is no reason for the Chinese to try and influence Pyongyang’s behavior. Beijing will continue to give the impression of being a possible partner in dealing with Pyongyang so they can measure the risk of unilateral US action.  This is political ruse at it's best. 

The countries with the most to lose from a US unilateral strike on Pyongyang are the Japanese and of course, the South Koreans. America cannot ignore South Korean opposition to a unilateral strike, given the possibility of retaliation against Seoul. There is also the issue of a complete disruption of relations with the Asian Region if the US puts its security alliances with Seoul and Tokyo at risk by not working with the Beijing.

The disintegration of US influence in the region and dismantling of Obama's failed "pivot to Asia' is the greatest risk. An exchange with North Korea will certainly trigger a wider conflict between China and the US. That's the bit that most people don't quite grasp, including Mr. Trump. 

A Walk Down Proxy War Lane

A bit of history will help here. Like it or not, the US has a nasty habit of policing rogue countries (real and imagined) when their leaders threaten to destabilize world order, start wars or threaten US national security. I am not going to argue the various negative aspects of this interventional model, but the list includes the Iranian Ayatollahs in the 70's, The Nicaraguan and Colombia drug lords, the Yugoslavians, Bosnians, Russians in the 80's. Osama Bin Laden in the 90's and early 2000's--followed in the quick succession of Hussein, Qaddafi, bashar al-assad, Putin and now Kim Jung Un.  

(I reference the work of Paul Craig Roberts in the following analysis.)

Yugoslavia:  Slobodan Milosevic, the Serbian president, was branded “the butcher of the Balkans,” and compared to Hitler (of course) until Hillary passed the title on to the President of Russia. Milosevic was arrested and placed on trial at the International Criminal Tribunal and died in prison. Some say murdered before he was cleared of charges by the International Criminal Tribunal. 

Iraq: Saddam Hussein never had “weapons of mass destruction,” weapons that the UN arms inspectors verified did not exist. Iraq was decimated over a period of nearly eleven years. Five thousand US troops died, hundreds of thousands were disabled by IED and PTSD, while, millions of Iraqis were killed, orphaned, widowed, and displaced. Saddam Hussein too was subjected to a show trial more transparent than Stalin’s trial of Bukharin and then murdered under the pretext of judicial execution.

Libya: The failed US Mission in Libya and death of the US ambassador there was based entirely on the alleged  criminal misuse of the UN no-fly resolution by turning it into a NATO bombing of Libya’s military so that the CIA-armed jihadists could overthrow and murder Muammar Gaddafi.”

Syria: The Obama administration claims the planned US invasion of Syria that was blocked by the UK Parliament and the Russian government.  General Mike Flynn says it was a “willful decision”  to send ISIS to Syria over his objections as Director of the Defense Intelligence Agency.  Is there a coincidence Mike Flynn got ousted from the new administration? 

Ukraine: Some believe that the US orchestrated the coup the democratically elected government and replaced it with a neo-nazi regime. Ukrainian democracy was indeed threatened by a Russian invasion. However, the question remains as to who was there first.

The new not so new crazy guy.

North Korea is no different and neither is Kim Jung Un. 

North Korea is not a "normal" state, and its leader is, in fact, a thirty-three-year-old whack-job. Jung Un's repeated bellicose threats against the US sound much like the Ayatollahs in the 70's and 80's. Jung Un likes to kill his own family members who oppose him, and keeps the country in relative poverty. Pyongyang has zero interest in developing a clear nuclear doctrine nor allowing its' people greater freedoms. If this sounds familiar to Iraq--well you are an astute geopolitical reader.

Consider also that the domestic backlash here in the US against allowing North Korea to acquire ICBM nuclear capability would be far greater than the war cry was for an attack on Baghdad. You must recall that Saddam did not threaten the United States with weapons he did not have. 

The former prime minister of Australia, Kevin Rudd, who is also president of the Asia Society Policy Institute in New York, suggests Beijing accept a unilateral US strike as credible--and work towards a change in diplomacy towards North Korea. Rudd believes that the US should urge China to bring about a cessation of North Korea’s nuclear program and the destruction of its existing arsenal. The US would then accept the much discussed “grand bargain” for the peninsula, including a formal peace treaty with Pyongyang, diplomatic recognition by the US, guarantees for the regime’s future, the possible withdrawal of US forces from South Korea and the removal of sanctions.

The sad part is that Rudd is dreaming. 

Part Two: Trading War Rumours

The Dog Days of Summer

Consider that the heated rhetoric between the leaders of the United States and North Korea has created a peculiar and oddly-timed uncertainty for the market. August tends to be when trading volumes are lightness and the fact that the U.S. market that is long overdue for some a sizable correction after what an eight-year bull-run. A geopolitical shock would result in wider than normal market swings and drive volatility. Who might be behind that? Well for one, the banks. Increased volatility would mean an influx of dollars in the market when it is quiet. 

Valubit analyst Eric Parnell suggests that the associated regional and global market indicators show no sign of imminent conflict

Thanks to continued QE and the ineptitude of global central banks policy-makers, the U.S. stock market is now an accurate indicator of how monetary policy can inflate asset prices and disconnect them from the reality of the underlying economy. The S&P 500 Index (SPY) or the Dow (DIA) are no longer useful in predicting where the economy might be headed.

Keep that in mind. 

The KOSPI

The Korean Composite Stock Price Index, or KOSPI, is the primary benchmark for stock market performance in South Korea. A preemptive episode could completely transform and potentially destroy the South Korean economy, so deal flow in response to a potential military conflict would first show up in South Korean (EWY) stocks.

The KOSPI fell  -3.2% last week. A decline that can hardly be considered, "panic selling". Yes, a -3.2% decline to 2,319 is notable. However, it is an entirely reasonable. The Korean market that was up more than +20% year to date in hitting new all-time highs at 2,453 just a couple of weeks ago in late July.  Nor is the KOSPI technically oversold so it would require a pull back all the way to  1900 to 2100 range before we could begin to suggest that war was imminent. So far, the KOSPI has only fallen back to levels that would have represented new all-time highs as recently as late May.

Meet me at the safe haven. 

When war is about to break out, capital will evacuate in search of havens immediately. There are entire cottage industries built around this concept.  Yes, Korean currency has weakened relative to the U.S. dollar (UUP) since late July; but it remains measurably stronger for the year to date. Parnell points out that comparing the Korean Won to the U.S. dollar lead to distortions in its right since the U.S. is also directly involved in the potential conflict. Even though the US would participate directly in the conflict, the global haven of choice remains the U.S. dollar. If anything this should remind us of the age-old adage that war tends to be "good" for the economy.  However, the US currency today remains at its lows dating back to the start of 2015 despite a smallish uptick last week. 

Bonds and Bombs

If war were coming,  we would expect to see at least some degree of weakness in the PowerShares Emerging Market Sovereign Debt (PCY) ETF, not only because some of the largest bonds in the product are Korean but also because it has heavier weightings in the more speculative emerging markets in the region.  Just like the KOSPI and the associated currencies, risk averse investors would draw back their capital in search of safety. Emerging market bonds are not showing any signs of stress. They are also holding technical support and nearer to all-time highs. 

Save the very shiny things for last.

Traditional safe havens of gold (GLD) and silver (SLV) rose in recent days, it has hardly been a breakout that would be associated with extreme market stress. Gold rallied, but it was already rising before the recent escalation in rhetoric over the past few days. Gold is trading at the top end of its recent trading channel just below 1,300 an ounce and is well below its 2016 highs at 1,377 per ounce. Silver has risen strongly by more than +7% in recent trading but is locked below downward and trending resistance dating back over a year to June 2016.

By the way, in case you have not found it in your spam folder, ex-CIA market spook Jim Rickards is selling a 4.95 guide to haven investing in metals and a 5k private equity play for a gold mine in Alberta. Go figure. An ex-CIA guy with an investment plan that hedges on global economic collapse. 

Yes, we Americans tend to stick our nose where they don't belong--but Pyongyang is not a place we can do that. While the reader might be troubled by the escalating braggadocio between the leaders of the United States and North Korea, the primary indicators in those markets signal little probability of the outbreak of war. By keeping an eye on selected market indicators we come to realise that we live in a post-market, post-historical time when the barking politician has been relegated to his proper position--that of a noise making animal whose contraventions will not ruffle the astute investor. 

Beware the Pundits

However,  ALL the major News outlets rely on drumming up fear to get you to stay tuned, so their reports are by definition overblown and as bombastic as the claims they cover. Be sure to get media should not be used to access or quantify the magnitude of actual risk of market exposure or war. The saying "buy on rumor and sell on news" should be replaced by "Observe markets movement and ignore the Pundits." Obtain an accurate accounting of geopolitical risks versus the latest news reports provides a dimension of analysis that most will not take the time to acquire. 

Either way, best to tread carefully right now.

I say have a look at VIXX. 

 

*The author is not a registered investment advisor and therefore not required to disclose any positions he may or may not have associated with the market. Nor should anything be taken as advice herein--except for the part about avoiding the news outlets and learning to read charts. 

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