North Korea Is Probably a Long Way From ‘Land of Opportunity’

US President Donald Trump and North Korean Supreme Leader Kim Jong-un apparently had a modestly successful discussion at last week’s summit, pledging “joint efforts to build a lasting and stable peace regime on the Korean peninsula” and making symbolic gestures to denuclearization and pressing pause on US/South Korean “war games.” Whilst foreign policy wonks, Twitter and body language experts immediately dissected the proceedings and statement, some media commentary began salivating over the prospect of a newly open North Korean economy, full of natural resources and development opportunities to exploit. Some investors have apparently already based trades on this thesis, sending some South Korean Industrials firms’ share prices sky-high this year in anticipation of their winning North Korean contracts.^[i] However, we would implore readers to cool their jets: Investing isn’t a get-rich-quick scheme. North Korea may eventually open up and yield actual investing opportunities, but this is probably a long, long, long way off.

Media enthusiasm seems concentrated in two main areas: infrastructure development and North Korea’s vast reserves of rare earths (metals such as scandium and yttrium, which are widely used in computer and smartphone manufacturing, among other commercial and industrial applications) and other natural resources. But we believe there are numerous obstacles standing in the way of these. Not least of all: North Korea is still communist. Most workers don’t earn money, getting by instead on bartering. As The Telegraph explained in a recent article: “For the most part workers do not receive wages. Instead, payment in kind is made - if there is any payment at all. It is therefore, by in-large, a barter economy with huge levels of bonded labour. Put another way: swathes of the population are thought to be enslaved in addition to being generally oppressed and are likely to have to trade foods, fabric or coal, in order to get by.”^[ii] Meanwhile, the country has nothing resembling modern capital markets—no modern monetary system (which would include a central bank that sets interest rates in a free market as well as robust currency exchange facilities), no national banking network to serve households and very few foreign capital links. In short, we think North Korea is short on the main ingredients of economic growth: human capital, technology, capital and productivity. They appear to have a lot of catching up to do.

As you might imagine, North Korea also lacks an equity market. The only way for retail investors to “invest” there would be to own shares of listed foreign companies that win contracts there—which we believe explains the big run-up in all those South Korean firms. We suspect this run-up is a strong indication that these seemingly breaking developments in the North are already reflected in current share prices. Moreover, these are all speculative bets, in our view—investors today are seemingly just guessing which firms might eventually win contracts if Trump and Kim strike a bigger deal someday. These are uncharted waters, making it impossible to assess actual probabilities. We think probabilities are a much sounder basis for investment decisions than distant possibilities.

Those seeing big potential in North Korean investments, in our view, would do well to consider the story of Myanmar. In 2012, the country’s then-government—a military junta—made waves and sparked hope by lifting its barriers to foreign investment. In 2015, it had made enough progress on the political front to inspire the US to drop sanctions. Within a year, longtime opposition leader Aung San Suu Kyi was a free woman and a member of a newly democratically elected government, and the Yangon Stock Exchange (YSE) was open for business. Financial media globally cheered the prospects of the world’s next great Emerging Market, boasting of opportunities for investors to capitalise on rapid infrastructure and income growth. Yet today, two years later, the YSE has just five listed companies—two banks, two holding companies and one Telecommunications firm. It is also down -56.1% since its April 23, 2016 inception when measured in US dollars, which is how the exchange reports returns internationally (UK investors’ returns in sterling may be higher or lower, depending on currency fluctuations).^[iii] It boomed out of the gates, then busted, and it has been flat for about a year. Foreign investors still can’t access it. There are no Myanmar index tracker funds.^[iv] The closest investors can get, according to our research, is one fund tracking companies currently doing or expected to do business in the country, including some Myanmar companies that currently trade on foreign exchanges. The index presently includes 15 companies and has underperformed the MSCI Frontier Markets Index since its inception in late 2012.^[v] In its latest report on opportunities in Myanmar for foreign investors, the British Chamber of Commerce cited many of the same issues North Korea faces. Modernisation is happening much more slowly than the world seemingly hoped.

For investors keen on finding opportunities outside of the supposedly stodgy developed world, we think there are more transparent avenues with better risk controls. The category known as Emerging Markets—e.g., China, Taiwan, Mexico, Brazil, India and their ilk—has many of the same drivers investors seek in North Korea now, but with much more transparency, modern capital markets and much less state intervention (China aside). The category one rung lower on the development latter, known as Frontier Markets—Argentina, Romania, Nigeria, Kenya and the like—also falls into this realm, but with more political risk and less developed capital markets. Neither category has inherently more upside potential than developed markets, in our view. Our analysis of global market history shows leadership frequently ebbs and flows amongst these categories. But all have at least some semblance of capital markets (and some are very near earning developed-world status). You can track their performance through MSCI—a global equity index provider covering most of the world—and other publicly available sources. They are accessible to foreign investors and relatively liquid.

Based on our observations of world history and the domestic situation, we believe it will probably be a long time before North Korea ticks any of these boxes. For all the hoopla surrounding the summit, it strikes us as entirely symbolic. Kim Jong-un did not say he plans to transition North Korea to a market economy and let foreign firms enter joint ventures there. Nor did he say anything about privatising whatever big state-run firms might exist there and let his people own a slice, much less foreign investors. “Profit” is probably still considered a dirty word by the communist leadership. So don’t get too excited.