North Korea Is a Long Way From 'Land of Opportunity'

President Trump and North Korean despot Kim Jong-un officially made nicey-nice at Tuesday’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.” While foreign policy wonks, Twitter and body language experts immediately went into full-on dissection mode, investors began salivating over the prospect of a newly open North Korean economy, full of natural resources and development opportunities to exploit. Some investors have already made plays on this thesis, sending some South Korean Industrials firms sky-high this year in anticipation of their winning North Korean contracts. As ever, we would implore readers to cool their jets and remember 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.

Investors’ enthusiasm seems concentrated in two main areas: infrastructure development and North Korea’s vast reserves of rare earths and other natural resources. But there are about a bazillion 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 today: “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.” Due to this system and the general ravages of communism, most of the population outside of Pyongyang is malnourished (or toiling away in a gulag) and undereducated. Meanwhile, the country has nothing resembling modern capital markets—no modern monetary system, no national banking network and very few foreign capital links. In short, North Korea is short on the main ingredients of economic growth: human capital, technology, capital and productivity. They have a lot of catching up to do.

As you might imagine, North Korea also lacks a stock market. The only way to “invest” there would be to invest in listed foreign companies that win contracts there—which explains the big run-up in all those South Korean firms. We suspect said run-up is a strong indication that these seemingly breaking developments in the North are already priced in. Moreover, these are all speculative bets, in our view—investors today are just guessing which firms might eventually win contracts if Trump and Kim strike a bigger deal someday. This is all terra incognita and not a market function, making it impossible to assess actual probabilities. We think probabilities are a much sounder basis for investment decisions.

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. Everyone cheered the prospects of the world’s next great Emerging Market, eager to capitalize on rapid infrastructure and income growth. Yet here we are, two years later, and the YSE has just five listed companies—two banks, two holding companies and one Telecom firm. It is also down -56.1% since its April 23, 2016 inception.^[i] 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 ETFs or mutual funds. The closest investors can get is one ETF that tracks 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.^[ii] In its latest report on opportunities there for foreign investors, the British Chamber of Commerce cited many of the same issues North Korea faces. Modernization is happening much more slowly than the world hoped.

For investors keen on finding opportunities outside of the stodgy (kidding) developed world, we think there are better avenues. Emerging Markets—China, Taiwan, Mexico, Brazil, India and their ilk—have 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). Frontier Markets, which are a rung lower on the development ladder—Argentina, Romania, Nigeria, Kenya and the like—also fall into this realm, but with more political risk and less developed capital markets. Neither category has inherently more upside potential than developed markets. Leadership regularly ebbs and flows among 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. They are accessible to foreign investors and relatively liquid.

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 privatizing whatever big state-run firms might exist there and let his people own a slice, much less foreign investors. “Profit” is probably still a dirty word. So don’t get too excited.