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By Platinum Tiger

A negative turn in investor sentiment on Friday sent the Rising China Stocks index tumbling to a 2.5 percent decline, wiping out gains from earlier in the week and dropping the index to its first weekly loss in a month.

The decline, which came on heavy volume, was precipitated by news that the SEC had charged Goldman Sachs (NYSE:GS) with fraud in its subprime mortgage derivatives trading. Even though there is no direct correlation between Goldman's legal troubles and the profitability of U.S. listed small cap Chinese companies, Friday's market action underscored the inherent volatility of these small caps, and their vulnerability to negative news in the broader U.S. markets. Despite their distance from the events at Goldman, the RCS index stocks fell harder and farther than those in either the Russell 2000 index (down 1.3 percent on Friday) or the S&P 500 (down 1.6 percent).

[Click to enlarge]Given the extent of the rally for Chinese small caps this year--they had gained more than 21 percent for the year as of last Thursday--a correction has been looking increasingly inevitable. As was previously noted in this column, index gains have been coming on lower breadth and volume recently. And other market signals, such as retracements in commodity prices, have been indicating a likely turn in the broader markets.

Declining stocks outnumbered gainers on Friday by a margin of nearly 4 to 1. Real estate and energy stocks were particularly hard hit, with each sector declining 8 percent from the prior Friday. Pharmaceuticals were the biggest gainers, advancing 7 percent for the week. Among individual stocks, standouts included Jiangbo Pharmaceuticals (OTCPK:JGBO), up 25.6 percent for the week, and China Electric Motor (OTCPK:CELM), up 19 percent. Hardest hit were fertilizer manufacturer Changda International (OTCPK:CIHD) and China Shuangji Cement (OTC:CSGJ), down 17 percent and 24 percent, respectively.

If Friday's decline develops into a full correction for Chinese small caps, it won't likely last for long, as recent earnings reports have been generally strong among RCS stocks, PE multiples remain low, and the Chinese economy, despite a few sector-specific 'bubble' threats, appears to be back on track for another year of double-digit growth.

Disclosure
: JGBO.OB
Source: 'Goldman Friday' Demonstrates Volatility of Chinese Small Caps