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Short overvalued Chinese stocks

Published in collaboration with Against All Odds Research

Every so often, Western investors grow enamoured of Chinese stocks, only to learn time and time again that it just doesn't pay to invest in that country. Be it Sino Forest or Luckin Coffee, accounting frauds are numerous and investors get fooled into buying worthless stocks. Then there's Chinese tech. Chinese tech stocks were once treated on par with US tech stocks - until the CCP cancelled the Ant Group IPO and investors suddenly awoke to political risk in Chinese tech. Recently, the CCP has started going after education companies and threatened to turn them into non-profits. They have also banned bitcoin mining.

Unlike Kyle Bass who has it in for everything Chinese, I bring this up to make a point - Chinese stocks are risky and need to trade at a discount to reflect that risk. Yet, there's one group of Chinese stocks which currently doesn't

"The move would mark the first financial investment by the U.S. military into commercial-scale rare earths production since World War Two’s Manhattan Project built the first atomic bomb. It comes after President Donald Trump earlier this year ordered the military to update its supply chain for the niche materials, warning that reliance on other nations for the strategic minerals could hamper U.S. defenses. China, which refines most of the world’s rare earths, has threatened to stop exporting the specialized minerals to the United States, using its monopoly as a cudgel in the ongoing trade spat between the world’s two largest economies."

Since the covid crash, the VanEck Vectors Rare Earth/Strategic Metals ETF (REMX), which tracks the overall performance of companies involved in producing, refining, and recycling of rare earth and strategic metals and minerals, moved from a low of $23.91 to peak at $115 earlier this month. The ETF has a wild 1 year return of 151%. No doubt, this outperformance has something to do with US government funding for US sourced rare earths.

Only, the premise based on which investors have obtained rare earths exposure is false.

This is a poorly constructed ETF, albeit one which has done quite well for the last 17 months. The stocks which constitute the ETF are priced to perfection with crazy high PE and PB ratios. The ETF itself has a PE ratio of 17.25x and PB ratio of 4.25x as of July 31st.

“Economic history is a never-ending series of episodes based on falsehoods and lies, not truths. It represents the path to big money. The object is to recognize the trend whose premise is false, ride that trend, and step off before it is discredited.” George Soros

Worth repeating the quote here, since this is indeed the case with REMX. I consider yesterday's gap down in REMX the start of the discrediting process. If I'm right, we have a long way to go.

Short REMX at ~$103 with a stop above $115 and a target of ~$40

Given the risk reward I see in this play, I would be comfortable giving it another try if my first attempt fails.

Good Trading!


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