For those of us with the interest and intestinal fortitude to want to invest in the great small cap growth companies of this China juggernaut, having April behind us is heaven sent.

March was the month of revelation. The month we, in fact, learned there is widespread fraud amongst China small cap companies.

When I launched this publication last October, I was confident I could uncover some great opportunities for subscribers and for myself. The first six weeks were a cake walk. I had 4 or 5 huge short term wins on my list.

It started to get a bit tougher in late November when the Shanghai A shares index fell 11% in four trading days as the market priced in the inflationary cycle in China. About 4 interest rate increases and a number of other tightening measures haven’t slowed inflation enough quite yet.

Then February and March came, and short sellers stated their case in a very public way- they very cleverly identified a few companies they believed were committing fraud, and the sector became a blood bath akin to a Freddy Krueger movie.

I knew they’d likely be right in a few instances, but thought I had the right move on the highly controversial China Media Express (Formerly NASDAQ and still halted CCME). Despite all the evidence the company’s numbers were on the up and up, the short sellers proved out, and I was dead wrong. Plain and simple- I blew it, and it cost me plenty in cash and credibility.

In 23 years of trading in the small cap environment, I’ve never wondered if I should invest over concerns the company was publishing fraudulent numbers. That’s a whole new arena for me.

I’m an journeying to the heart of NY- Times Square, to attend an all day seminar next Friday, hosted by a panel of experts, to teach me how to identify fraud in China companies. Never too late.

At one point I was so demoralized I was almost ready to abandon this service. However, a little perspective saved the day. 23 years of actively trading the market can teach you a lot.

I thought back to the two great cataclysmic events of the first decade of the 21st Century. Stock market devotees are describing it as the “lost decade”. Large caps were dead money for 10 years.

But, was it really a lost decade? Not if you played your cards right. Consider the first cataclysmic decline- the demise of the Internet stocks- that period of 2000 to early 2002 when all the rah rah boom Dot Coms turned into Dot Bombs. Stocks traded down from $100 to $1. 911 didn’t help, which was closely followed by Enron, World Com, and a host of the companies that shook the confidence of the American investor.

If you had the discipline when stocks traded below the value of the cash they had in the bank, and had the capital and courage to step in, you could have made a fortune investing in any surviving dot com in late 2001 and early 2002. The values were remarkable.

Then in 2008 we had a once in a century financial melt down. Overleveraged banks were dropping like flies, and our Government helped in a rather distasteful manner by bailing out the perpetrators of the biggest pyramid scheme in history- the sub prime mortgage meltdown. The Goldman Sachs, Lehman Brothers, and AIGs of the world made Bernie Madoff look like a carnival barker.

The market went into a free fall for months and commerce in the US economy came to a screeching halt.

However, once again, if you had courage and cash, the fortunes of a lifetime were there to be had. I can’t say I was personally clever enough, but I have friends who own Ford (NYSE: F) at $1.80, and Apple (NASDAQ: AAPL) under $100.

Fast forward to today’s China small cap market. Short sellers, to their credit, forced the issue, and I can count 9 China small caps halted for trading on my screen.

There has been a bloodbath in the sector, but I’m learning from the past, and realizing many of these will prove out to be the buys of a lifetime.

We haven’t completed the bottoming process quite yet, but some of the cream is starting to rise to the top.

With the month of April behind coupled with a little perspective, I now believe we can tip toe through this minefield and find a Shangri- La of profits on the other side. Again- those with the cash and courage can make the fortunes of a lifetime as the loud noise of fraud gives way to the more consistent sound of corporate achievement, and a return to more reasonable valuations.

This will happen with time, insider buying, cash dividends, tender offers, corporate performance, and the inevitable unmasking of the remaining offenders.

To summarize my thoughts- hang in there- we’re going to make a fortune as we get past this unfortunate period in time and the bargain hunters start to get emboldened.

Big Picture: The Shanghai A Shares

The first thing I do every morning is look at a chart of the Shanghai “A” shares. This is the index in China which mostly closely mirrors our S&P 500. These are the China large cap stocks most of which are partly government owned.

Here’s a long term look.

This chart looks a lot like our NASDAQ Composite. Our peak at 5,400 was March of 2000.

The Shanghai A shares attracted all the hot money in late 2007. In 2008, the China large caps followed our market down the toilet.

In Q1 of ’11 we’ve recovered nicely. China is behind, mostly due to inflation and tightening, the arch enemies of stock appreciation.

Until this market really breaks above those green trend arrows, the China stocks will struggle a bit. I thought we might be in for a breakout last month, but high fuel prices sabotaged the inevitable.

It’s going to happen as soon as the market perceives China has beaten inflation. Despite their red hot economy, growth will slow, inflation will go away, and this market will to go back to Goldilocks and off we’ll go- it will happen later this year.

Playing the Yuan

Here’s the deal. The dollar has been going lower down, and the Yuan- the Chinese currency, has slowly crept up.

Global economists, the US in the lead, have long complained the Chinese have artificially held down the value of their currency to make their exports cheaper and therefore more in demand.

However, the Chinese have a big problem exacerbated by this policy, and most China watchers believe the YUAN is finally going to be allowed to appreciate more rapidly.

China is now importing a lot of food and fossil fuels. Those prices are going up. In the month of February China had a trade deficit for the first time in decades.

One way to combat this problem is to allow the YUAN to appreciate more rapidly. If there currency strengthens, their imports become cheaper.

If you want to bet on the appreciation of the YUAN, CYB- the Wisdom Tree Dreyfus Chinese Yuan Fund is a way to do it. This ETF is designed to provide a total return by being long both Chinese super safe debt and the YUAN relative to the US dollar.

This ETF is about very stable, and should appreciate very slowly over a long period of time

If you want to place a bet on the Chinese YUAN with a pile of your “safe” money, CYB is the way to do it.

The YUAN broke through the 6.50 level to the dollar on Friday, matching it’s highest valuation since 1993. Analysts expect the YUAN to appreciate about 7% in 2011, and there’s still nearly 6% to go.

I’m adding it to the currently unpopulated Large Cap section on the site.

Warmest Regard,
Larry Isen
Emerging China Stocks
www.emergingchinastocks.com

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