The nonsensical shelling of a South Korean island has again brought up the issue of reunification — along with the 250,000 diplomatic cables released last weekend from the whistleblower website Wikileaks. In this mountain of sensitive information there were interesting details about the North and how eventual reunification would play out.

Cablegate revealed that a South Korean diplomat predicted the collapse of North Korea within a couple of years after the death of Kim Jong-Il. Apparently, China was frustrated over the North Korean regime’s unpredictability. Also, it became clear that South Korea’s Vice Foreign Minister Chun had had conversations with several Chinese officials who privately indicated that Beijing would be comfortable with Korean reunification under the Seoul government under certain conditions.

In my opinion, North Korea would have long been reunited were it not for the support of China. China has only two real allies in Asia — Burma and North Korea — so they may have thought they needed them to influence regional politics. But having grown economically so much in the past 10 years, the Chinese now influence the region via trade policy.

China, not the U.S., is now South Korea’s biggest trading partner. The latest available data from the CIA World Factbook show that Korea consistently runs a trade surplus with China. Korea’s main export partners are: China 21.5%, U.S. 10.9%, Japan 6.6%, Hong Kong 4.6%. While Korea’s main import partners are: China 17.7%, Japan 14%, U.S. 8.9%, Saudi Arabia 7.8%, UAE 4.4%, Australia 4.1%.

There has been conscious decision made by the Chinese leadership to strengthen trade ties with its Asian neighbors at the expense of the West. China ends up running trade deficits with many Asian neighbors (like South Korea), but surpluses with many Western countries.

Korea may be an advanced economy, but similarly to Japan it is poor in natural resources. It is the most liquid stock market in Asia after China and Japan, but it does exhibit great volatility. It is not really an emerging market any more similar to Singapore, as it is way more advanced than many of the markets in the region with nominal GDP/capita of $20,165. But the country has made great progress since the Asian Crisis in 1997 and any sizeable corrections in the Korean stock market should be used as opportunities to add to positions.

The best proxy for Korean stocks is the Korea iShares (NYSE: EWY).

Korean ADRs have not done much in 2010, even though the Korean economy has done just fine. There aren’t too many U.S.-listed Korean companies available, but the huge exposure to China may have concerned some investors due to the coming deliberate policy-driven slowdown there.

As fears of a policy overshoot in trying to slow the Chinese economy subside, the biggest laggards in the table above should become the leaders.