Stockhouse Ticker Trax is equity specific research (Canadian listed and market cap < $300 million) published every Monday to paid subscribers. Our free Friday column may feature companies previously featured to paid subscribers (with a minimum one month delay) or discuss topics of interest to the general investment community and relevant to overall portfolio management.
I may be over-estimating the risk faced from North Korea in 2013 but I am not taking any chances when it comes to my investments. I take enough risks with penny stocks, I don’t need to be blind-sided in 2013 by North Korea.
This week I prepared a report that outlines the risks faced from North Korea and (in theory) how to help protect your portfolio should the situation escalate. The impact on world stock exchanges would be significant if the United States was dragged into a war with this country (especially with the NYSE trading near its 5 year high). However, the biggest blow would be to the South Korean stock exchange. The ETF – (NYSE: EWY, Stock Forum) EWY.Z tracks the performance of that exchange.
EWY can be utilized to hedge your bets. My personal Stock Option strategy that I mention below is an “all or none” approach so I view it like portfolio disaster insurance. For others you may be able to short the ETF or find a different approach.
Either way, don’t underestimate what is happening in Korea this year. The risks are far greater than we have seen in a very long time. ____________________________________________________
North Korea - Portfolio Protection Strategy
Many people have very different views on how serious North Korea is to world stability - my personal opinion is that (at least on the surface) many government leaders don't seem to take the threat from Kim Jong-un serious enough.
At only 30 years old, Kim Jong-un was under the wing of his father who had a very real hatred of the United States. Other than his closest family and advisors, no one knows how he thinks or what his plans are. He likely believes other country leaders don’t take him serious or respect him. His actions since taking power are those of a man who is out to prove something and is willing to risk it all in the process.
North Korea has spent decades preparing for the day they will go to war with South Korea, the United States, and their close allies. For more than two decades there is no doubt that Kim Jong-un has been educated around this belief. Now that he is in power, he has wasted no time proving to the world that he means business. In the past there has been a line they would not cross. Is Kim Jong-un preparing to re-draw that line?
Just over a week ago, an official video from the North Korea government was released on YouTube. It is a dream sequence that depicts a nuclear attack on what many interpret to be New York.
https://www.youtube.com/watch?v=9FbmmsDYObU
This past week North Korea tested a miniaturized nuclear device - only days after the United States implied North Korea was simply posturing. January 24th North Korea made the following official statement:
"We do not hide that a variety of satellites and long-range rockets which will be launched by the DPRK one after another and a nuclear test of higher level which will be carried out by it in the upcoming all-out action, a new phase of the anti-U.S. struggle that has lasted century after century, will target against the U.S., the sworn enemy of the Korean people," the statement reads. "Settling accounts with the U.S. needs to be done with force, not with words as it regards jungle law as the rule of its survival."
There should be no doubt, Kim Jong-un is extremely dangerous - and he is running a country with significant military capacity and nuclear capability. The United States has a powerful military and incredible nuclear capability. However, this would not be a war they could easily win.
Take ten minutes and read the following Military Abstract prepared a decade ago by something called “the Director Center for Korean Affairs”. It definitely makes you stop and think. The military capability of North Korea is definitely strong but few seem to have any concrete numbers. If you can put a satellite into space, and test a nuclear bomb, you should not be under-estimated.
https://rense.com/general37/nkorr.htm
In addition to traditional warfare, the analyst believes North Korea would launch cyber-warfare and quite possibly take the battle directly to United States soil.
Coincidence or not, within the report above is also a reference to cyber-warfare by the North Koreans (they have their own computer virus and hacker battalions). The following story appeared in Reuters on Tuesday (only days after the North Korea nuclear test)
https://www.reuters.com/article/2013/02/12/us-obama-cybersecurity-idUSBRE91A15U20130212
It seems the risk in 2013 of a serious confrontation with North Korea is greater than we have seen in a long time. On the off chance North Korea comes off the rails and drags the United States into a war, we would see a dramatic hit to North American stock exchanges, and a devastating blow to the South Korean stock exchange.
November 2010 - North Korea hits the South with several artillery shells - their stock exchange fell approx. ten percent. March 2010 - North Korea sub sinks small naval ship - their stock exchange fell approx. 20% over the next two months.
PUT Options on EWY.Z
While this strategy would only work if you are familiar with shorting or buying stock options, you could bet "against" the ETF that tracks the performance of the South Korea Stock Exchange - EWY.Z $60.57 (iShares South Korea Index Fund).
Unfortunately you either need to know how to do this, or have an advisor who can assist you with it. There are too many variables that must be taken into consideration.
What I am personally doing is taking a higher risk, higher rate of return approach by purchasing "out-of-the-money" PUTS on EWY that are cheap and would expire within two months. If nothing occurs within that time frame, the PUT Option expires worthless and you lose the entire amount. If something dramatic were to occur within that two month window, the payout (rate of return) is huge - even on a bet of only a few hundred dollars.
Tuesday for example I purchased EWY Puts for 12 cents that are good only until April 20th and have a $51 strike price.
A person could buy puts that don't expire until the summer (or even later), but they start to get more expensive the farther out you go. In my case, I will likely keep turning over the same short term strategy every couple months for 2013 (and possibly 2014).
Should tensions escalate and stock exchanges be adversely affected, any losses I may occur on normal stocks would be offset with gains on the stock option - because I am gambling that the South Korean stock exchange would fall dramatically.
This is an all or nothing strategyso I call it portfolio insurance. It is protection against an event that could (in theory) have a huge negative impact on stock markets. If nothing happens, I lose maybe a couple thousand dollars within a year (on buying the EWY Puts), but I have the comfort of knowing any big hit to my stock portfolio, could be offset with the gains from the South Korea stock option position - assuming in this case, the event is related to North Korea.
If your portfolio is large enough that you would worry about any impact from North Korea, then it is worth talking to an advisor about option strategies or reading up on them. They are extremely high risk, but generate significant returns if you time them properly.
I hope I am wrong on the risks we face from North Korea. But either way, read the military abstract I noted above and educate yourself on this situation. It is important to be well informed - in case this does escalate over the next year.
___________________________________________________________________
Disclosure: Danny Deadlock owns 50 April Put Options on EWY.Z
_______________________________________________________________________
In addition to this weekend column and the bottom fishing research sent to paid Ticker Trax subscribers on Monday, I also provide free MicroCap alerts throughout the week.
These are based upon News or Abnormal Price/Volume Activity on the several hundred stocks we track from our own research, brokerage analysts, or 3rd party newsletter writers.
https://stockhouse.com/Groups/GroupInfo.aspx?g=50540
https://twitter.com/TSXAlerts
_______________________________________________________________________