Fears Of Second Korean War Weigh On EWY

by on May 21, 2010 | ETFs Mentioned:

When a South Korean navy vessel sunk following an explosion in March of this year, many within Korea and in the international community immediately became suspicions of North Korea’s involvement in the tragedy. Officials in South Korea refrained from assigning blame to their rivals to the north in the immediate aftermath of the incident, noting that a thorough investigation would take time to complete. But now armed with a report conducted by experts from the U.S., U.K., Australia, and Sweden, South Korea has officially blamed North Korea for the blast that killed 46 sailors.

The international investigation has concluded that the sinking of the naval ship near the North Korean border was caused by a North Korean torpedo. The investigation team reportedly recovered part of the torpedo on the sea floor that matched design and lettering found on North Korean torpedoes previously collected by South Korea.

The long-suspected conclusions have spurred South Korea to take a hard stand against North Korea and sparked concern in the international community. Earlier today South Korean Defense Minister Kim Tae-young warned of retaliation. “Even in a boxing match the fighters agree to wear gloves,” said Kim. “North Korea has stepped over that limit and for that we will make it pay.” North  Korea has threatened war over any retaliation, indicating its desire to send its own team of analysts to investigate the evidence accumulated (also see Three Country ETFs Ripe With Risk).

On Friday, South Korean president Lee Myung-bak gathered his top security ministers for an emergency meeting. Claiming that North Korea’s actions constituted both a military provocation and a violation of both the United Nations charter, Lee issued a stern warning. “It is a grave and serious matter,” he said. “We cannot make a single mistake in implementing countermeasures.”

South Korea ETF Sinks

Equity markets around the world have plummeted this week as concerns about Europe’s drag on global growth continue to linger. Uncertainty over the next steps in the increasingly tense standoff between North and South Korea has crushed the iShares MSCI South Korea ETF (EWY), which lost 6.4% on Thursday and has dropped more than 10% on the week.

The recently-launched IQ South Korea Small Cap ETF (SKOR), which tracks the IQ South Korea Small Cap Index, has also been hammered in recent days. SKOR slid almost 8% on Thursday, bringing its decline since the beginning of the week to more than 12% (read more about the differences between EWY and SKOR).

Although the Finance Ministry in Seoul claims that the fallout from the sinking of the warship will “not have a significant impact on the economy,” investors have clearly been rattled by the accusations against North Korea and promises from Pyongyang that retaliation will lead to war. Despite the public confidence, it is clear that South Korea is concerned over the impact of a potential conflict on one of the world’s fastest-growing economies (see South Korea: Developed or Emerging Market?). Finance Minister Yoon Jeung-hyun met with government officials to assess the impact of the increased geopolitical risk on South Korean markets, and a task force to assess and monitor the economic ramifications has been set up as well.

Disclosure: No positions at time of writing.