Bargain Hunting After China Stocks Run-up Can Be Risky

Gene Linn |

Bargain Hunting after China Stocks Run-up Can Be RiskyInvestors are struggling to find low-priced China stocks after a big run-up. Some may be taking more risk than they think.

The blue-chip Hang Seng index in Hong Kong soared more than 12% in January fueled by gains in banks and other big cap stocks before stalling out in early February. Then Wednesday the Hang Seng shot up 2.1% to 21,365 as a large rise in local property stocks carried the Index over the 250-day moving average, triggering strong technical buying. The index of Chinese companies jumped 2.4% to 11,686. Turnover was heavy.

While the market was consolidating in early February, investors turned to second and third liners searching for bargains. Jackson Wong, vice president of sales at Tanrich Securities, called it a “treasure hunt.”

Many of these smaller companies have become expensive. Ben Kwong, chief operating officer at KGI Asia, said now some investors were looking at companies that “usually are not popular – shell companies.”

These companies may look like they have good valuation ; the Bloomberg Chinese Reverse Merger Index plummeted 51% in the last year. And they feature companies in the fast-growing private sector. But it is a risky place to look for treasure.

Dozens of these shell companies listed in the U.S. and Canada failed last year, Andy Mantel, CEO and founder of Pacific Sun Advisor, said in a December article in The Gloom Boom & Doom Report. Institutional and retail investors lost tens of billions of dollars.

The problem with these companies starts at the beginning, Mantel said in an interview with Equities, when private Chinese companies merge with listed U.S. shell companies, so-called China reverse mergers. Promoters of these companies sometimes make extravagant and fraudulent claims for these mergers and make a handsome pile of money on commissions and/or short-selling even if the company goes belly-up.

So what is an investor to do? Not surprisingly, Mantel suggests, they rely on funds like Pacific Sun’s Greater China Equity Fund. Such funds have the resources and experience to do due diligence on the sometimes obscure Chinese companies involved in reverse mergers, he said.

And Pacific Sun is looking at a few of these companies, considering the low price and the attractiveness of Chinese private companies. Mantel says Pacific Sun does a great deal of research on these stocks and prefers those that are family-owned or have reliable shareholders.

While urging caution in investing in Chinese reverse mergers, Mantel noted there are some positives. One is that most listed Chinese companies are on the up-and-up. Another one is there is pressure on the Security and Exchange Commission and exchanges to identify and weed out fraudulent reverse mergers.

“I’m positive this will be cleared up,” Mantel said. He said investors will look back on this mess in a few years and be glad it’s been cleaned up. End

DAILY FIX

Hong Kong Blue Chips: +272, +2.1%, to 21,365, 02-15-12, Hang Seng Index

Chinese Stocks in Hong Kong: +272, +2.4%, to 11,686, 02-15-12, HSCE Index

Shanghai Stocks: +0.9% to 2,367, 02-15-12, Shanghai Composite Index.

Chinese Stocks in the U.S.: +4.7, 410.8, 02-14-12, Bank of New York Mellon, ADR Index-China

Insight: Hong Kong opened slightly higher, then in mid-morning shot straight up as strong gains in local property stocks pushed blue chips above the 250-day moving average, triggering heavy technical buying. SHK Properties (SUHUY) rose 4.6%. KGI Research

Quotable: "Asian markets may react nervously on the cancellation of Euro-zone finance ministers’ meeting." 02-15-12

Chinese Company to watch: China Construction Bank (CICHY) "The index tracking funds will have to buy stake, which will support the stock price over short term." Kingston Securities. 2-14-12

Brokerages and analysts cited here have disclaimers on their websites emphasizing their statements are for information only. They do not endorse my blog, and I don't endorse them.

For a list of Chinese companies sold in the U.S. and information on each company go to http://www.adrbnymellon.com/dr_country_profile.jsp?country=CN

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

Companies

Symbol Name Price Change % Volume
CUDA Barracuda Networks Inc. 22.89 -0.40 -1.72 262,347

Comments

Emerging Growth

New Age Farm Inc.

New Age Farm Inc is engaged in the development of the agriculture based business in Langley, British Columbia.

Private Markets

Cross Campus

With over 500 members and operating 80,000 square feet by summer 2016, Cross Campus is one of the country’s top ten shared, collaborative office or "coworking" operators in the US.…

Wealthfront

Wealthfront is an automated investment service that serves as an alternative to traditional financial advisory services. The company manages a diversified, continually rebalanced portfolio of index funds on their clients’…