Under the Radar advocates both a defensive and offensive attitude to portfolio construction for those investors worried about the problem of North Korea. After all, given the unpredictable nature of the two main protagonists, the North Korean crisis is shaping up as one of the most unsettling geopolitical events for investors, not to mention greater humanity, in decades.
It’s impossible to know how the escalating tensions will be resolved, but the answers probably are (a) very badly or (b) not at all.
In any case, investors should not ignore the disturbing situation when it comes to constructing their portfolios. Global share markets have held up reasonably well since North Korea in July fired a long-range missile into the Sea of Japan. But with revelations that the rogue nation may possess a hydrogen bomb and intercontinental ballistic missile capabilities, the sternest test may be yet to come.
Not surprisingly the gold price has risen over the last month, by 6% to around $US1336 an ounce. But the safe harbour metal is still below its 2011 record high of $US1890/oz. and was trading at $US1350/oz. a year ago.
The firming price is partly related to a weaker $US. Non-precious metals, notably copper, have rallied as well amid reports that the global economy is strengthening.
Given the apocalyptic consequences of a North Korean attack on its near neighbours of South Korea and Japan, a US-led defensive strike on the hermit kingdom is considered to be long odds.
At the risk of understatement, China’s role as North Korea’s immediate neighbour and only ally further complicates things. Talking of complicating things, Donald Trump’s rhetoric has turned from fire and fury analogies to trade sanctions against parties that support North Korea with commodities such as food and oil.
The key party of course is China, which is Australia’s most important export partner for raw materials and a key source of other income such as education services.
If China’s trade to the US is curtailed, the effects would be felt not just by our iron ore and coal miners but value added providers such as Blackmores and Bellamy’s.
If conditions deteriorate further and the market panics, there may be few places to hide. Under the Radar has been advocating a small exposure to gold stocks for some time now as a hedge against disastrous scenarios. Given gold is sold in US dollars, Australian gold producers are benefiting from the weakening AUD over the past 5 years, which has assisted in lowering their costs relative to offshore competition.
The issue is not so much whether to be exposed to the yellow metal, but the nature of the exposure. A tool such an exchange-traded fund (ETF) will give a de-facto exposure to bullion, while some will want to hold on to the physical gold directly.
Under the Radar’s small cap portfolio includes gold ETFs. The other exposure is via Australian gold producers that are low cost and boast extensive reserves. That’s why we like our premier producers, Northern Star Resources and Evolution Mining. We also like the global producer OceanaGold, which has alsobeen performing well.
The flipside to the North Korean imbroglio is that western countries are likely to boost their defence budgets relative to GDP. In the case of the US, Donald Trump promised a massive defence expansion even before he was elected in December.
A surprising number of ASX small caps are directly exposed to defence spending both here and in the US. Take one of Under the Radar’s long time favourites, the ship builder Austal, which makes ships for the $6.4bn US littoral combat program, as well as patrol boats for the Australian Navy.
Specialist carbon components Quickstep supplies parts for the massive Joint Strike Fighter program, although the company’s performance has disappointed over the years.
Other examples are the drone manufacturers Xtek, Orbital and Department 13. Elsewhere the defence space includes the fire retardant material producer Alexium International and the defence and aerospace technology group Electro Optic Systems.
In theory, these stocks should do well although execution remains the key. Because of the sensitivities, defence stocks can take years to procure.