Summary:

• Pyongyang’s nuclear test a serious sign for global leaders
• No easy answer for US and its allies
• Any military action could result in major moves on Gold, USDJPY and US500

North Korean threat is not new to the markets and each and every incident has had only limited (in scale and time frame) repercussions as traders moved onto other topics. However, Sunday test is different and we’ll explain why. We also highlight three markets that could see major moves should this geopolitical threat spin out of control.

What makes this nuclear test different from other forms on military manifestations from Pyongyang is a clear sign of capabilities to actually become a nuclear power. Korean nuclear ambitions have been apparent and official, it has been known for a long time that a dynasty of Kims sees this objective as the priority and opportunity to play a major role on the global geopolitical map. However, it’s been also broadly believed that diplomatic isolation and economic backwardness would make it very hard, if impossible, for the regime to actually acquire vital nuclear technology. Until now. Initial reports suggest that Sunday’s explosion was 10 times more powerful than a previous one in a test conducted a year ago and could represent a bomb that would destroy a major chunk of a big city. Military experts believe that North Korea could already posses a true Hydrogen Bomb or be very close to having one. Now all the Pyongyang needs is a missile to carry such bomb long enough, a field where progress has been reported as well. 

This could be a real game changer. Until now, the US and its allies sought to pursue a strategy of economic isolation to make it impossible for the regime to acquire nuclear technology. Now this strategy seems to have failed. Economic sanctions could kill more people in the country due to starvation but seem insufficient, especially at this stage. Kim Jong Un could be close from considering himself a nuclear power at which point he will seek major concessions from international society. What could US and its allies do? Execute a military strike now and risk Seul to be peppered by artillery strikes? Or let Korea make that final nuclear step risking unpredictable consequences and sending an awful signal to other countries with nuclear ambitions (Iran)? How will China adjust its policy now that a strategy of “quiet support” for Pyongyang have presumably failed?

3 markets to watch: Gold, USDJPY, US500

There are too many question marks and no obvious answers. For the markets North Korea is a very asymmetric risk – investors do hope that tensions will easy and “business as usual” would return. However, should this conflict escalate (think preemptive strike of the US coalition or a Korean “test” that is actually seen as a direct attack) major moves on those markets could follow:

Gold

Gold prices have actually been on the rise even as other markets were more sanguine about geopolitical risks. With the $1300 level broken, bulls could eye $1377 multi-year highs as their next target. Eruption of conflict could help gold as US bond yields could collapse well below 2% and demand for safety could increase strongly. In such case a break of the $1377 level could look like a “walk in the park” with the next target as remote as $1560.

Gold prices are close to multiyear high at $1377/oz. Source: xStation5 

USDJPY

USDJPY like gold has been very sensitive to a situation on the Treasury market. Because the Bank of Japan forced a “cheap currency” policy, USDJPY actually follows the US 10-year Treasury yield. In case of a conflict that USDJPY could tank not only because these yields could collapse but also because the Japanese could bring back their vast savings back home. It’s easy to forget that USDJPY tested 100 late in 2016 – the pair could revisit these levels should geopolitical conflict materialize. 

USDJPY hangs on above the key 108.25 support but could crush towards 100 in the event of any direct military conflict. Source: xStation5 

US500

Equity markets have ignored geopolitical risks amid favourable economic conditions and supportive central bank policies. However with Wall Street at all time highs actual military conflict could change this perception and cause a market correction at best or a severe bear market (if a global trade is seriously disrupted) at worst. The last serious correction occurred in late 2015/early 2016 and stripped 320 points off the US500 (S&P500 futures based CFD on xStation platform) and we have not seen any real profit taking this year yet. 

 

The US markets like US500 are yet to see a correction this year. Source: xStation5