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Discovery Investing: Joining the Nuclear Club

Michael Berry
0 Comments|October 9, 2006

Membership has its privileges for gold, oil investors

Membership has its privileges for gold, oil investors

North Korea joined the most important club in the world this morning. The isolated nation announced it had exploded a nuclear device in a 6000 foot deep former coal mine. North Korea called the test a "great leap forward." Russia indicated the device was larger than expected. The Soviets (oops, sorry the Russians) said it was approximately the size of the bomb dropped on Hiroshima, equivalent to about 15,000 tons of TNT. Russia's Putin has called for an international response. The United Nation's IAEA chief Mohamed El Baradei told reporters:

"There will be disastrous political repercussions in Asia and the rest of the world. I think there could be major environmental fallout, which could lead into dissemination of radioactivity in the region. I hope every leader who has contact with North Korea is on the phone today with North Korean authorities to dissuade from test."

This event has monstrous implications. North Korea is a pariah in the world. It starves its people to spend 80% of GDP on the military. Its military troops are larger than that of the U.S. With its conventional forces alone, the North Koreans are likely capable of handling its southern neighbors including the 37,000 American troops in the south.

Military alert levels have increased all over Asia this morning. South Korea called the test a "provocation." China has been embarrassed. China signaled the U.S. that it could control the rogue nation. The assurance was ground into dust yesterday deep in a North Korean coal mine. China has been the country's main benefactor over the past 53 years. This test is a significant blow to Chinese prestige. A nuclear rogue nation next door could derail the Chinese QOL cycle.

The event has also pushed Japan more closely into the arms of the Chinese. The new Japanese Prime Minister, Shinzo Abe, will visit China shortly (not the Yasukuni War Shrine?). He will also visit with South Korea's Prime Minister Roh Muy Hyun. The Japanese are beginning to see the writing on the wall. It may be in their best interests, particularly in view of the NK nuclear test, to seek a rapprochement with the Asian neighbors it treated so badly in WWII. North Korean missiles are very capable of striking Japan. The NK nuclear test is highly significant.

More important, the U.S. congressional elections are only weeks away. What opportunity might the Bush Administration seek in this event? Neither the Clinton Administration nor the Bush Administration have been able to deal effectively with North Korea. If the response to this provocation is a military intervention, South Korea would be severely impacted.

Finally, and perhaps most important, the Iranians have a front row seat. They can now decide whether to join this club. If the North Koreans are allowed to stay in the club and blackmail its members, the Iranians, with significantly more muscle than North Korea, must also join. It will be a fait accomplis. A nuclear Middle East is a much more serious development that a nuclear North Korea. But it is in the cards, Discovery Investing readers, unless the world acts now.

In the meantime, our leaders must ask what the North Koreans and the Iranians really want. John Meacham, editor of Newsweek, suggested this morning that the North Koreans simply want a little respect. May I suggest another hypothesis? The North Koreans want to dominate the Korean peninsula and northeastern Asia. This test takes them much further down this road. The North has tested intermediate and long-range missiles capable of carrying nuclear weapons. Iran also has aspirations to dominate the Middle East, in my opinion. It wishes to export the religious fervor of radical Islam to Europe and the world. A nuclear Iran would be untenable. The West's efforts in Iraq and Afghanistan would be placed in doubt by nuclear neighbors.

The North Korean act has, indeed, wide-reaching implications. The balance of power in the region and the Middle East may have changed. In this event, the expectations for the price of oil and gold have just taken on a new life, even though the spot prices have barely budged. In the meantime, an outcast has "joined the club."

Michael Berry has been a portfolio manager for both Heartland Advisors and Kemper Scudder, where he successfully managed small and mid-cap value portfolios. He was a professor of investments at the Colgate Darden Graduate School of Business Administration at the University of Virginia and has also held the Wheat First Endowed Chair at James Madison University. Dr. Berry is now a proponent of what he calls "discovery investing."

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