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The Chinese solar industry has been one of the top-performing sectors over the past month, despite threats of a slowdown in the U.S. and E.U. end markets. Germany recently announced it would be lowering feed-in tariff rates by 15% next year, while a group of U.S. solar panel manufacturers recently filed a petition against the Chinese solar industry that could result in new import duties.

Despite this seemingly bad news, Chinese solar stocks have rallied over the past month:

  • Suntech Power Holdings Co., Ltd. (NYSE:STP) +21.3%
  • JA Solar Holdings Co., Ltd. (NASDAQ:JASO) +28.2%
  • LDK Solar Co., Ltd. (NYSE:LDK) +35.3%
  • Trina Solar Limited (NYSE:TSL) +45%
  • Yingli Green Energy Holding Co., Ltd. (NYSE:YGE) +46.2%
  • ReneSola Ltd. (NYSE:SOL) 48.6%
  • JinkoSolar Holding Co., Ltd. (NYSE:JKS) +98.4%

So, what’s happening? There are several possible explanations. In the short-term, Germany’s move to curb feed-in tariffs could cause a flood of new solar installations between now and the end of the year when these changes go into effect. And in this kind of pricing environment, Chinese solar companies remain the most competitive in the solar industry.

Meanwhile, recent financial performance has helped add fuel to the fire. During the third quarter, First Solar Inc. (NASDAQ:FSLR) announced a 20% year-over-year and 53% sequential increase in revenues, while its net income also rose 10% year-over-year. These results were mimicked by many others in the industry that saw similar strength, while most announced plans to cut spending to boost future results.

And finally, the recent progress in resolving the European financial crisis has also helped boost the sector (along with stocks in general). Improvement in solar companies’ end market could help increase spending, while improved government finances could help reduce the severity of solar cutbacks.

But what does the future hold? Chinese solar companies face a number of key challenges ahead. First, anti-dumping lawsuits from both the U.S. and E.U. could lead to some repercussions. Secondly, the eventual reduction in government subsidies in the E.U. will slow down demand after the upcoming surge that many investors are anticipating. And finally, the global economic system is not yet steady.

Investors with exposure to China’s solar sector may therefore want to take some precautions. For instance, purchasing protective puts or covered calls can help limit risk or take money off the table. Or those that see China outperforming the U.S. solar sector can also consider a pairs trade between the two countries to take advantage of the disconnect and hedge against a larger solar decline.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Source: Chinese Solar Stocks' Hazy Outlook