North Korea's apparent test of a hydrogen bomb spurred a quick and fairly predictable response by investors, given that the US market was closed for the Labor Day holiday. The funding currencies, like the yen and Swiss franc, were bought back, gold rallied, and equities were sold. 

While playing up the fact that all options, including a military response, are on the table, and claiming that North Korea is "begging for war," the US appears set to push for greater sanctions.  It is not clear whether there is unanimity in the UN Security Council for more sanctions at this juncture. Shortly following a unanimous vote in the Security Council in early August, the US followed up with unilateral sanctions against Chinese and Russian companies and individuals that reportedly irked Beijing and Moscow.  The key sanction that even the US does not seem prepared for is to embargo oil and food. 

On the other hand, there are voices urging the acceptance of the fait accompli from North Korea. It has the bomb.   It appears to can deliver it.  There is a good reason to believe that it could survive a first strike by US allied forces and launch a devastating strike against South Korea, Japan, and possibly the US mainland.  A year ago, it launched a ballistic missile from a submarine, and this year, during the US-South Korea-led military exercises, it conducted a test of it most destructive weapon to date.  

This fact needs to be accepted. That North Korea joined the ranks of nuclear powers is not new news for investors.  The uncertainty now lies with the potential US response.  Geopolitical risk often produces a dramatic but short-lived response. 

The dollar fell to almost JPY109.20, which is the 61.8% retracement objective of last week's bounce. The low was set in early Asia as the markets reopened from the weekend.  In contrast, the Swiss franc did not record its peak until late in the European session.  This is true of its performance against both the dollar and euro.  The franc's outperformance may be a function of market positioning.  Many reached the same conclusion we did that the franc is a better funding currency than the yen, given rates, volatility, and central bank commitment. 

Asian shares were lower, except China, where the Shanghai Composite added 0.4%. The MSCI Asia Pacific Index fell 0.6%, and Korea's Kospi fell twice as much.  It gapped lower and approached the August low near 2310, which itself was a three-month low. 

The Kospi is fallen in five of the past six sessions, though of note, foreign investors were net buyers of South Korean shares both before and after the weekend.  That said, one difference now is that the geopolitical backdrop has been joined by the possibility that the US  makes good on its threat to give notice that it will withdraw from the free-trade agreement with South Korea.  

European equities also were the red.  The Dow Jones Stoxx 600 lost nearly 0.5%, which is what it gained last week.  All sectors but energy were lower.  We monitor the correlation between (the percent change) of the euro and Dow Jones Stoxx 600.  On a 60-day rolling basis, the correlation is the most inverse today (-0.51) than it has been since Q2 16.  Even on a purely directional basis, the correlation is negative, suggesting that the main driver of the euro is no long unhedged flows into European equities. 

Gold rallied. While we find arguments explaining the strength of the yen and Swiss franc as a function of their use as funding currencies, rather than as safe havens, gold looks more like a pure haven play.  Gold briefly traded above the highs set in the immediate response to the US election results last November (~$1337.5).  It rose about 0.7%, with the gains coming in Asia before consolidating in Europe.  Since breaking above $1300 it has been on a bit of a run and has appreciated for six of the past seven sessions. 

Some reported tried linking gold’s gains on Monday to China’s decision to ban initial currency offerings. These are the equivalent of IPOs in equities except what is purchased is the initial offering of a cyber currency/token of the issuer, often recorded on an Ethereum blockchain.  An estimated $4.5 bln has been raised in such offerings.  Many cyber currencies, like Bitcoin, fell on the news.

The rally in the industrial metals was also extended. Chinese demand is seen as the main driver.  Nickel rallied over 2% to new two-year highs.  Copper gains more than 1% to a new three-year high.  At the London Metals Exchange, the metals have enjoyed an eight-week rally coming into this week.  The record was nine weeks set in 2006.  Ironically, the dollar-bloc currencies traded heavily, more weighed down perhaps by the risk-off than by the high metals prices. 

Some reports over the weekend suggested that UK Prime Minister May was privately conceding that it may cost the GBP50 to leave the EU.  It was denied by Brexit Secretary Davis, but the eventual amount may be near this figure. Consider that from the EU's vantage point, the UK is responsible for the 14% of its budget that it had pledged until 2020.  Without putting too fine a point on it, assume the EU budget is about 1% of members GDP (~$16.5 trillion) or $165 bln.  Assume the UK is responsible for 14% of that (or $23 bln) for 2018, 2019 and 2020 or a cumulative amount of around $69 bln or GBP54 bln. 

Sterling traded heavily, though within its pre-weekend range.  A break of the $1.2860-$1.2880 area would signal a break down of the constructive technical tone that had been building. 

The euro was firm.  It recouped everything it had lost against sterling in the wake of the unsourced story warning that the ECB may not be ready to announce next year's balance sheet intentions until December.  The euro was also firm against the dollar.  It was initially marked down in Asia, but the pre-weekend low near $1.1850 held and the euro recovered and was still trading tightly near the $1.1920 high in late European turnover.

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