(01/03/12) 2 Opportunities As Korea Transitions

The death of Kim Jong-Il has momentarily destabilized the region, but after the shock, there are ways for savvy investors to take advantage of the shift, writes Yiannis Mostrous of Investing Daily.

Two weeks ago, North Korea announced that its longtime dictator Kim Jong-Il had died and that his son, Kim Jong-Un, will lead the reclusive nation. The market reacted immediately to the news by selling South Korean stocks (the KOSPI dropped 4.2% initially) as well as the South Korean currency, the won.

The South Korean army and government were put on full alert, and the country’s central bank and market regulators called an emergency meeting. Since that time, both the market and the currency have recovered their losses.

We’ve written repeatedly that North Korea was one of the flashpoints in the Asia-Pacific region, regardless of whether Kim Jong-Il remained in power. But barring an outright nuclear confrontation, North Korea doesn’t represent a real threat to South Korea, and investors should purchase South Korean shares on any market pullbacks.

Nevertheless, Kim Jong-Un’s ability to consolidate power and exert influence on North Korea’s military remains in question. Kim Jong-Un is in his twenties, and as the youngest son of the former leader, he is not the natural heir to the throne.

Although some senior members of his father’s regime should remain in place, no one can predict his hold on power or the ferocity of infighting among key power brokers within the secretive state.

North Korea’s hermit-like status means that the most credible source of information on the rogue state is the Six-Party Talks, which will most likely continue, albeit at a slow pace. However, the recent decision by the US to provide food assistance to North Korea is a good sign that communication channels remains open.

The unification of North and South Korea will be the ultimate game changer on the Korean peninsula. This long-term development—if indeed it ever happens—could result in significant fiscal hardship, as was the case when Germany was unified. However, we also know that South Korea would not mind getting its hands on North Korea’s nuclear capability.

Unless North Korea reacts to these events by firing missiles, as it did in 2009 and 2010, the market should stabilize. But any military show of force by North Korea will elicit a violent reaction from the markets. We recommend that investors buy South Korea equities when markets pull back.

The best outcome for the markets and South Korea would be a continuation of the status quo. The biggest danger would be a popular uprising in the North, akin to the Arab Spring.

Such a development could lead to an unpredictable reaction from North Korea’s military. In a worst-case scenario, North Korea may escalate hostilities with South Korea in order to divert attention from domestic upheaval.

But we consider this a remote possibility, and South Korea remains a favorable market for investors. Those seeking exposure to the South Korean market should consider the country’s leading banking group, KB Financial Group (KB) and LCD panel manufacturer LG Display (LPL). At current levels, LG Display’s stock is also a worthy candidate for value investors.