Korea ETF In Freefall As North/South Tensions Escalate

by on May 25, 2010 | ETFs Mentioned:

When a South Korean navy vessel sank near the North Korean border this year, some in the international community became anxious that the historic rivals were headed towards a conflict that could destabilize the region and undermine a still fragile economic recovery. At first, it seemed as though cooler heads would prevail; South Korea refused to direct blame at Pyongyang until all the evidence had been gathered and analyzed.

Now a group of international experts has concluded that the explosion on the South Korean ship, which killed 46 sailors, was the result of a North Korean missile. If tensions had cooled at all in recent weeks, they have once again reached a boiling point in recent days as a series of maneuvers on both sides has captured the attention of the international community. The North Korean government issued a statement on Tuesday declaring its intent to “totally freeze” relations with South Korea and withdraw from a nonaggression pact between the two countries. According to the statement, the North “formally declares that from now on it will put into force the resolute measures to totally freeze the inter-Korean relations, totally abrogate the agreement on nonaggression between the north and the south and completely halt the inter-Korean cooperation.”

Meanwhile, South Korean president Lee Myung-bak said he was once again considering designating North Korea as his country’s “principal enemy,” a term dropped in 2004. South Korea has launched a series of initiatives against the North, including economic sanctions. On Tuesday the South launched a radio station near the border that will broadcast into the North, a unique tactic against a country where freedom of the press is virtually non-existent.

Tensions between North and South Korea are nothing new. The two nations have technically been at war for more than 50 years; no peace treaty was signed after the Korean War, and the demilitarized zone between the two countries is among the most armed borders in the world. But following two North Korean tests of nuclear explosives, the gravity of the conflict has increased considerably.

Korea ETF In Freefall

The escalation in tensions between North and South rippled throughout the global economy, as the latest negative development in a disastrous May hardened investor risk aversion from Australia to Wall Street. But the conflict has had a particularly devastating effect on the iShares MSCI South Korea Index Fund (EWY), which had dropped 4.5% in late afternoon trading on Tuesday and is down more than 20% month-to-date. Also read Three Country ETFs Ripe With Risk.

Despite adamant assertions from government officials that an “extreme case” of hostility is unlikely, South Korean equity markets have taken a rough beating in recent sessions. On Tuesday, deputy minister Shin Je-yoon headed to the U.S. to meet representatives from Moody’s, Standard & Poor’s and Fitch in an effort to prevent rapid downgrades of Korea’s credit ratings (see all ETFs in the Asia Pacific Equities ETFdb Category).

Also tumbling on Tuesday was the IQ South Korea Small Cap ETF (SKOR), which lost 6.8% in afternoon trading. Whereas EWY’s holdings consist of mega cap companies headquartered in South Korea, SKOR tracks the IQ South Korea Small Cap Index, a benchmark measuring the performance of small cap stocks listed on Korean exchanges. Because they avoid exposure to multi-national firms that generate revenues globally, small cap international ETFs often offer more “pure play” exposure to local economies. On Tuesday, that means a particularly steep fall for SKOR (see the SKOR fact sheet).

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Disclosure: No positions at time of writing.