Canadian investors pay far less attention to South Korea than they do to China – and that's a mistake. South Korea offers a much better read than its larger rival on where Canadian stocks are headed next.
The chart below demonstrates how the KOSPI, South Korea's primary equity benchmark, and the S&P/TSX Diversified Mining Index have moved in tandem over recent years. The correlation between the two indexes is a remarkably high 0.92 – substantially higher than the correlation between domestic mining stocks and the Shanghai composite.
The tight relationship between South Korean markets and Canadian mining stocks has a simple explanation: both reflect Asian economic growth. The continent's increasing prosperity drives demand for South Korean manufactured goods; it does the same for Canadian raw materials.
The recent divergence, in which the Canadian mining index has fallen below the KOSPI, suggests that Canadian mining stocks are undervalued. But the South Korean market also has wider implications: It offers what is arguably the best window on what is really happening in Asia.
Unlike the Shanghai composite, the KOSPI is broadly diversified across many sectors (although admittedly within a small number of conglomerates); it also includes a number of major global players such as Samsung and Hyundai that have no Chinese counterpart.
South Korea's banking sector was restructured after the Asian credit crisis and the country remains an integral part of the global supply chain in steel, electronic components, and shipping. Importantly, South Korean corporations use globally accepted accounting practices, offering investors a far higher degree of transparency than their Chinese counterparts.
Despite many Canadians' impression of developing nations as backward, South Korea is now a sophisticated, diverse economy producing some of the world's highest-quality goods. Its gross domestic product per capita is now $30,254 (U.S.) according to the World Bank, ahead of New Zealand, Israel and Portugal. It is an emerging economy in name only.
The relative strength of the South Korean equity market in recent weeks is an optimistic sign for Canadian investors on two fronts. One, it suggests that selling in domestic mining stocks is overdone and that prices now understate the current level of global demand for basic materials. Also, the KOSPI's ability to reflect activity in China means that domestic investors can view recent positive Chinese economic data points with more confidence.