"The canary in the AI bubble has just died," and the South Korean government is shirking responsibility by saying "we won't bail out the market for now."

Summary of Key Points

The recent sharp decline in the South Korean stock market, particularly in the semiconductor sector, has served as a canary in the mine for the bursting of the AI bubble. South Korea was one of the hottest beneficiaries of the global AI boom, but now it is the first to experience massive selling of funds: the semiconductor sector has lost nearly a third in value over the past month, with the 3x long ETF on South Korean stocks (KORU) plummeting from $64 to $14 (a 78% drop). The South Korean government has chosen not to intervene in the market immediately and has instead blamed structural issues within the market, which has sparked strong dissatisfaction among retail investors. This phenomenon could be a sign of a revaluation of global AI assets, indicating either a localized adjustment or the beginning of a broader collapse of the entire AI bubble.

Detailed Explanation

1. Why South Korea Became the “Canary” in the AI Bubble?

The term “canary” is used to describe an early warning system; for example, canaries are used in mines to detect toxic gases, and their death indicates potential danger for the miners. The South Korean stock market acted as such within the AI bubble:

• Previously a Favorite of the AI Boom: South Korean semiconductor companies (such as SK Hynix with its HBM memory and Samsung Electronics) are essential components of AI infrastructure (AI servers require large amounts of storage chips), attracting a flood of investment and making the South Korean market one of the most active for AI-related transactions.
• Now the First to Falter: On July 28, the semiconductor sector fell by 11%, and on the 29th, it dropped another 6%, resulting in a cumulative loss of nearly a third over the past month. More importantly, the South Korean stock market has risen faster than the Philadelphia Semiconductor Index (PHLX), which is considered a benchmark for the global chip industry. This suggests that South Korea may be experiencing the first signs of trouble within the broader AI market.

2. Leveraged ETFs: The “Accelerator” That Magnifies Losses

Many retail investors bought 3x long ETFs on South Korean stocks (KORU), which experienced a 78% drop. Why such severe losses?

• Leveraged ETFs Are Not Designed for Long-Term Holding: These funds rebalance their positions daily, aiming to achieve three times the daily index return, not a cumulative long-term gain. For example, if the index falls by 5%, the ETF will fall by 15%; if it falls another 5% the next day, the ETF will fall another 15%. This magnifies losses over time, and even if the index eventually recovers, the ETF may never return to its original value.
• Retail Investors Get Trapped: Many investors were unaware of this mechanism and thought they could easily profit from AI trends, only to end up with significant losses.

3. The Government’s Decision to Not Intervene: Retail Investors Are Angry

The South Korean government’s approach has enraged retail investors:

• Previously Encouraged Investment: The government promoted AI as a major opportunity and encouraged retail investors to buy semiconductor stocks.
• Now Shifting the Blame to Market Structure: Faced with the market crash, the government argues that market self-regulation is sufficient and blames factors such as active retail trading, excessive derivatives use, and the high weight of the semiconductor sector in the market. It also suggests that leveraged ETFs are not entirely responsible for the losses.
• Retail Investors React: Investors criticize the government for being inconsistent, saying, “You encouraged us to invest, but now you don’t care about our losses!” Although the government later apologized for the hasty introduction of leveraged ETFs, it still decided not to provide support.

4. SK Hynix’ Strong Performance Despite Losses: A Mirror of Excessive AI Valuations

SK Hynix’s recent performance has surpassed its historical best levels, yet its stock price still fell by 9%. This highlights a major issue with AI-related investments:

• Excessive Expectations: Market expectations for AI companies’ profits have been overly optimistic, driving up stock prices significantly.
• Even Good Performance Is Not Enough: Even if a company performs well, it will be sold off if its performance does not meet these high expectations. This indicates that valuations of AI assets are inflated.

5. Will Global AI Assets Also Fall?

The South Korean market crash is not an isolated event; investors around the world are watching closely:

• Potential Further Losses in U.S. Chip Stocks: Since the South Korean market rose more than the PHLX, it may now experience even greater declines. If the two markets return to their historical correlation, U.S. chip stocks could see additional losses.
• The Crucial Factor: Profitability: Whether investments in AI by U.S. tech companies (such as NVIDIA and Microsoft) will actually generate profits (for example, through AI chip orders or increased cloud computing revenue) is key. If these investments do not yield the expected returns, global AI assets may need to be revalued.

The question on everyone’s mind is: Is this just a localized issue (South Korea’s problem), or is it a sign that the entire AI market is facing a bubble that is about to burst?

Conclusion

The sharp decline in the South Korean stock market serves as a warning that the AI bubble may be deflating. If AI investments truly offer substantial returns, this could just be a temporary fluctuation. However, if not, global investors may have to confront the consequences of their previous enthusiasm. The experience of South Korean retail investors also serves as a reminder: Be cautious when buying leveraged ETFs and avoid blindly following market trends.