Full-Blown Rally Developing In China's Micro Caps

by: Markos Kaminis

Last week, I authored a research article titled China's High Flying Microcaps, perhaps a good read for those interested in the tiny giants. It will be especially important for investors following NF Energy Saving Corp., SmartHeat and the rest of the market moving names mentioned therein. The report detailed the reasoning for a freshly sparked rally in China's capital needy microcap names.

Tuesday, after the market close, I took note that China's tiny microcaps continued to litter the biggest daily percentage gainers list. In my report, I had warned that the early rally would spread and become inclusive of names that might not deserve or receive a portion of a coming stream of new foreign capital investment, just provisioned for by the Chinese government. I said that smart money would find safekeeping.

That said, I believe the market is still figuring out where those safe havens are. Tuesday's biggest movers list was inclusive of Guanwei Recycling Corp. (NASDAQ:GPRC), Ninetowns Internet Technology Group (NASDAQ:NINE-OLD), China XD Plastics Co. (NASDAQ:CXDC) and Recon Technology (NASDAQ:RCON).

Guanwei seemed to benefit mostly from a Seeking Alpha focus article written on it, which indicated that it had some fundamental support and a solid vote of confidence from a Global Hunter analyst. However, many of the others again seemed to lack any specific driver Tuesday, based on the newswire, and so I believe are attracting capital based on my prior reasoning in last week's article.

I think this is a sustainable run that will last more than a day trader's timeline. Initially, I noted that the starving microcaps with fundamental opportunity would seem most likely to benefit. Still, not all of China's small cap stocks are on the move, as seen by the last five day's of trading for the Guggenheim China Small Cap ETF (NYSEARCA:HAO). Some fast profits have been taken in China's early high flyers, but smart money should continue to seek the most deserving of them. Clearly, the onus is on the stockpicker to find the truly deserving names for new foreign capital investment. In that effort, there are many keys we might use to unlock where capital might flow.

For one, we might look at where institutions already hold positions as an early screen, since new money will likely use that information as a proxy as well. As far as this list goes, Yahoo Finance doesn't have any info on RCON institutional ownership. GPRC has a spattering of institutional holders including Calpers, AIG (NYSE:AIG), UBS (NYSE:UBS), PNC Financial Services (NYSE:PNC), WFG Advisors and Fidelity, as of December 2011.

Ninetowns was held by hedge fund Renaissance Technologies and Wedbush Morgan as of December 2011. CXDC seems to have the most institutional holders of this group, due to its small cap status and apparent auto opportunity. SmartHeat (NASDAQ:HEAT) has got a good number of holders, including names like Barclays (NYSE:BCS) and some of the names already mentioned. NF Energy (NASDAQ:NFEC) only lists Synovus Financial (NYSE:SNV) and UBS as institutional holders.

I'll probably employ another important screen in a future article, so stay tuned.

In conclusion

Microcap names or penny stocks carry risk and trade cheaply for a reason, though we measure "cheap" by valuation and not dollars and cents in the equity arena. The wild west of the developing world brings further risks to the game, and when nations are ruled by dictators or closed governments, well then you're riding bareback. That said, I see a near-term opportunity still available for aggressive investors seeking otherwise deserving Chinese companies that might now benefit from a new flow of capital. The onus remains on the stockpicker to find those names which can retain that capital and add value.

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