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Is the Korea ETF About To Breakout?

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The on-going political turmoil in the Korean peninsula has weighed heavily on investors. If anything, many consider the nation’s relationship with North Korea to be one of the primary concerns for investing in South Korea.

All in all, it has been tough going for investors with South Korean exposure following the North Korean leader’s latest round of provocative statements. In fact, over the past few weeks, the Korean equity market, the KOSPI Composite Index, has slumped around 4.16%.

On the other hand the ETF that tracks the performance of the Korean equity markets, the iShares MSCI South Korea Capped ETF (EWY - Free Report) has slumped close to 7.21%. This is because the South Korean won has also lost around 3.1% versus the U.S. dollar, which in turn has further brought down the effective rate of return for the Korean ETF compared to the actual loss for the Korean equities (read Three Country ETFs Struggling in 2013).

Apart from this, the South Korean economy has been facing macro-economic headwinds over the past few quarters. This is primarily due to the sluggish overseas demand as the nation is highly dependent on exports.

Beyond these fundamental issues, there are also technical problems, as we can see in the chart of the Korean ETF below:

The chart above is the two year weekly price chart of EWY. As we can see, the ETF has been channeled gradually into a narrowed, constricted trading range, forming the shape of a triangle.

This is a classic scenario which only explains the concrete headwinds that the South Korean economy has been witnessing. It occurs sometime due to economics, other times due to politics (see ETF to Short This Week?).

Nevertheless, the ETF has not been able to find any specific trend as the 50, 100 and 200 Moving Average lines have almost had an identical slope. Furthermore, with time, the three trendlines have come very close to each other. This also signifies that the ETF has been witnessing flat trading action leading to massive compression in its prices.

Also, the volumes chart signifies that all through fiscal 2012 into 2013, the trading activity has remained sluggish with diminishing volumes.

What’s Next?

While the facts above surely seem to be unappealing to most investors, it could well be the calm before the storm. This is because the triangle pattern in the above chart has almost come to an end. And the compressing price action that the ETF has been witnessing for quite some time could well breakout (read Time to Buy Emerging Market ETFs?).

Furthermore, in a situation like this we could well expect a big price move either way (upside or downside), especially after a prolonged compression. However, the odds are slightly tilted in favor of a move to the downside.

The ETF has very recently broken below the support line as well as all of the moving average lines. The catalyst for the same is recent political issues with the North. Still, it will be important to notice whether the current weakness could be the trigger for the ETF to make the big move downward that some are expecting.

Bottom Line

One way to establish an assertion regarding this would be to play the wait and see game and observe its price action in the subsequent weeks. A further downward move from current levels would indicate more weakness going ahead (see 3 ETF Strategies for the Second Quarter).

However, if it does manage to rebound from here onwards, it could well be a big move on the upside. Either way, the bottom line remains in that after a period of prolonged choppiness, the ETF is poised for an established trend which would mark the future course of direction for EWY.

Therefore, investors should be ready for a big move either way, and especially so if we see the situation in North Korea reach new heights (see more in the Zacks ETF Rank Guide).  

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