If you read the reasons for all of the wild moves in the commodities markets yesterday, you will read a lot about Ben Bernanke and perhaps reducing the chances for quantitative easing and economic data. You will read of upbeat Federal Reserve Board minutes and end of the month profit-taking. Yet, what you won't read a lot about but perhaps had as big of an impact as anything on trading was what can be described as the North Korean effect.
In a market where the geopolitical risk premium has been pumped up to a frenzied high mainly because of Iran, any sense that we might see a reduction in that risk premium would move markets in a big way. Market prices act exactly as you might expect if that risk had been reduced. Precious metals plunged and oil rallied back taking a hit after a bearish inventory report and the size of the moves were accentuated on the shocking and hopefully historic news coming from the State Department surrounding the North Korea Nuclear Program.
The New York Times broke the story by reporting that North Korea announced on Wednesday that it would suspend nuclear weapons tests and uranium enrichment and allow international inspectors to monitor activities at its main nuclear complex, a step that raised the possibility of ending a diplomatic impasse that has allowed the country's nuclear program to continue with no international oversight for years. It also said North Korea agreed to suspend its uranium-enrichment program, nuclear weapons tests and long-range missile launches in return for 240,000 metric tons of food aid from the United States.
While some experts think that this so-called moratorium on uranium enrichment does not really mean anything the news might suggest it leads to, a historic breakthrough could change the fate of many commodities going forward. If you think about it, the markets acted just like you would expect if North Korea were indeed to begin stepping back from its nuclear program. Though we learned from the new leader's father and grandfather that North Korea can’t be trusted, even a slight reduction in that tension can impact prices when that geopolitical risk premium is already high.
The big drop in gold was the most obvious reduction in the geopolitical risk premium. Many people have bought gold as they fear the aftermath of geothermal nuclear war. OK, I exaggerate a bit, but it has been obvious that gold historically rallies during times of war and uncertainty. Gold has performed as the risk-on play. Many times it has involved the rising fears surrounding Iran and that has been obvious in recent weeks. Oil, of course, just last week had the biggest influx of speculative open interest since May, based mainly on an increase in the Iranian Risk premium. If North Korea starts playing nice with the West, that will further isolate Iran as the “Axis of Evil" club may lose another member. According to The New York Times, Secretary of State Hillary Clinton said in congressional testimony that the “’announcement represents a modest first step in the right direction. We, of course, will be watching closely and judging North Korea's new leaders by their actions.’” And so will the markets.
White House spokesman Jay Carney was quoted as saying that North Korea's latest commitments “are very welcome, but obviously they need to be followed up by action." He said the United States is not formally linking its food assistance to any North Korean moves toward denuclearization.
Now, while it is likely that we are being played for a fool again so the North Korean regime can score some food for its chosen ones, it is also possible that this could be a new opportunity. The West, wanting to encourage this new behavior, will shower North Korea with cash and goodies, and that in turn will increase the demand for oil, grains, cocoa and sugar. In fact, already it is food that is turning North Korea. I know that in the past North Korea has taken our food and money only to covertly continue along that same evil path. Yet, with King Jong Il out of the way, perhaps maybe, just maybe, King Jong Un might not be as crazy as the old man. This could even knock a few minutes off of the world’s doomsday clock. Now I may be getting ahead of myself but, again, that’s what futures markets do.