Thursday, November 3, 2011
On September 2, Silvercorp Minerals (SVM) – a large silver mining company headquartered in China – announced it had received an anonymous letter alleging the company was a fraud.
Specifically, the letter accused SVM of fudging the numbers on its income statement to make it appear more profitable than it was, falsifying its silver reserves, and overstating its cash balance.
The stock dropped 30%.
This was particularly concerning to me since only three weeks earlier, I had recommended SVM as part of a covered call strategy to subscribers of my conservative, income-producing newsletter, Advanced Income. Instead of owning an easy trade on its way to generating a 20% gain in just four months, my subscribers were staring at a 14% loss.
To its credit, the company addressed the fraud allegations head-on. It posted its bank account statements – showing a large cash hoard – on its website. It re-published the latest geological reports verifying its silver reserves. And it presented copies of its tax receipts as proof of the company's profitability.
The stock price started to recover. I reiterated my confidence in the company and in the stock. I even went so far as to tell subscribers that selling uncovered puts on SVM – a lower-risk, income-generating strategy than owning the stock outright – at such inflated premiums was like "Christmas in September."
Then it happened again. Two weeks later, SVM got hit with more allegations of fraud. This time, it was problems with the company's accounting procedures, conflicts of interest, improper activities by the company's CEO, etc. SVM was getting hit with every allegation in the book.
And the stock got clubbed... again.
All the allegations have since been proven false. SVM is trading higher now than it was before the accusations surfaced. My subscribers are making money. And I'm feeling good about sticking to my own research rather than doing what most of Wall Street does when a Chinese company gets accused of fraud – sell first and ask questions later.
But I may have missed a bigger idea...
Has investor sentiment toward China gotten so bad that it's now time to buy Chinese stocks?
Think about it. Reaction to an anonymous letter was bad enough to knock 30% off the share price of one of the world's premier mining companies. That probably wouldn't have happened to an American firm. But since SVM is a Chinese company – and sentiment toward China is so bearish – investors panicked and dumped their shares at bargain prices. This happened even after SVM addressed each false fraud allegation point by point.
It's hard to imagine investor sentiment getting much more bearish than that. Of course... if it can't get much more bearish, it has to get a little more bullish. And as investor sentiment improves, so will the price action in Chinese stocks.
In fact, it's already happening. Take a look at this updated chart of the Shanghai Stock Exchange (SSEC)...
The last time we looked at this chart was in June. The index had just broken to the downside of its consolidating triangle pattern (the blue lines)... And I suggested the Chinese market could fall to between 2,200 and 2,400.
It hit that target last month. Now it's bouncing.
So far, it's only a small bounce. But given how pessimistic everyone is about China these days – how even the most unfounded accusations from an anonymous source can wipe out one-third of a company's market capitalization – you have to wonder...
Is it time to buy China?
My guess: yes.
Best regards and good trading,
Back in June, Jeff predicted a quick drop in the Chinese markets... Since then, the Shanghai Composite is down about 10%.
Gold and gold stocks are both up more than 10% since June… the S&P 500 is in negative territory.
Shale gas plays are starting a new uptrend... EOG Resources and Pioneer Natural Resources are up 40% in a month.
Big Marcellus and Eagle Ford play Cabot Oil and Gas breaks out to a fresh all-time high.
Technology stocks are the only major sector besides utilities trading above their 200-day moving average.