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The domestic market for Chinese stocks is overheated. That's putting it mildly. What I read that is happening in China is similar to what I read was happening in the US in relation to NASDAQ stocks in 2000. Housewives daytrading at home. Cab drivers giving stock tips. People emptying out savings account to invest.

Much of the problem is that until now, the 'red chip' index was a closed market open only to Chinese investors so it sort of trades in its own twilight zone. And suddenly well off Chinese don't have many outlets for their investing needs. So basic economics - lack of supply + huge demand = major price increases in equities.

BusinessWeek has a story that just touched on the surface that can be found here.

The interesting points are:

200,000 brokerage accounts are being created each day - this seems impossible, but even if it is half that number, that is amazing.

And more importantly from an investing thesis:

On Aug. 20, the State Administration for Foreign Exchange unveiled a landmark decision to allow Chinese citizens to invest directly in Hong Kong stocks. The move is widely regarded as an attempt to siphon off some of the liquidity that has been driving equities on the Shanghai and Shenzhen exchanges steadily higher.

Previously, individuals were restricted to purchasing $50,000 per year in foreign exchange.

The reaction in Hong Kong was euphoric. The benchmark Hang Seng index climbed nearly 6% on Aug. 20 on the news, 0.62% the next day, and another 2.78% on Aug. 22. By some estimates, as much as $100 billion in additional money could flow into Hong Kong-listed stocks by Chinese retail investors in the next 12 months.

Bottom line? There is going to be a lot of domestic Chinese money flowing into Hong Kong. A diversified way to play this trend is the iShares Hong Kong ETF (EWH). The ETF has popped in just 2 days from $16.50 to nearly $18.00 this morning, a 9% reactionary rise. So I am just starting a small position here and will be looking for a pullback to add more. This is quite an interesting opportunity with the potential for very nice long term returns.

Disclosure: No position

Source: The Long Case for Hong Kong