Short Sellers: Maybe Wait With Chinese ETFs

The Shanghai Composite index has tripled since mid 2005 and is up over 50% in 2007. Not surprisngly, former Federal Reserve chairman Alan Greenspan and others are warning of a “dramatic contraction” in Chinese stocks.

Makes one think of shorting the Chinese exchange traded funds [ETF]: iShares FTSE/Xinhua China 25 Index (FXI) and PowerShares Golden Dragon Halter USX China (PGJ). One problem is that it might be difficult to borrow units (according to comments on discussion boards), leaving the put options trading on the two funds (subject to time decay).

Also, selling the Chinese ETFs won’t be exactly like selling the sizzling hot mainland stocks. PGJ is based on shares of Chinese companies listed in the U.S. (ADRs); FXI is based mainly on Hong Kong stocks with exposure to China. The two are U.S. dollar (or equivalent) denominated

Both have have risen less dramatically: since mid 2005, FXI has doubled and PGJ is up 50% against the tripling in the Shanghai index. The latter has a price-earnings (p/e) ratio near 45 while FXI’s p/e is around 16 and PGJ’s is in the mid-twenties.

Thus, Chinese ETFs, the short seller's instruments, do not appear to be excessively overvalued. And whenever China’s capital controls are relaxed, notes BCA Research, Hong Kong-based Chinese shares could get a lift.

The p/e of 45 on mainland stocks may not signal excessive overvaluation yet either. BCA Research says the average p/e in the Nikkei, Taiwan TSE, and Nasdaq manias went above 100 before the bust came.

So short sellers may want to bide their time. Or, if we were Jesse Livermore types, we might try to ridie the upward momentum with a long position in the ETFs or their call options -- until stronger signs of a break emerged.

PGJ FXI 1-yr. chart:

Related Articles: 'Pao Mo': That's Chinese for Bubble; The Bubble Theorists Have Shanghai Wrong; Morgan Stanley China Closed End Fund: NAV Up While Market Price Lags; Is the Chinese Market Heading Towards a Bubble or Solid Fast Expansion?

Comments

[D CROW:]

Why no ETF for the Shanghai Composite Index?

2007 May 30 01:58 PM

[Larry MacDo...:]

Capital controls and yuan inconvertibility

2007 May 31 07:23 AM

[Joseph Feeley:]

Nice piece. Thanks. I am looking for a vehicle to short SCI.

2007 Jun 05 02:41 PM