Investment Report - July 2011: Opportunistic Levered

The Opportunistic Levered (Arbitrage on model had another rough month. The model was again hit by fraud concerns among Chinese companies and emerging markets stocks fell due to concerns over inflation pulling down growth.

Over the 29 months of tracking this model, it has had numerous months of 10% plus swings. Unfortunately some cases were to the downside. In those cases the stock holdings just got more attractive in the process. Even with China fraud scares, the three stocks owned in this model still appear to be worth more than our original purchase prices not to mention multiples of that.

The size of declines in some of the stocks in this model caught us off guard. It didn't surprise us that June was weak, but the level of weakness in several sectors such as industrials and emerging markets such as China caught us off guard.

Bottom Performers
The bottom performers were again lead by the China stocks in the model. ChinaCache International (CCIH) and Lihua International (LIWA) were both down roughly 20%. The extreme level of weakness in CCIH caught us completely off guard. The company is the leading content delivery network (CDN) provider in China. Think Akamai (AKAM) of China. The stock has dropped from a post IPO high of $35 during November 2010 to $6.40 during June. Somehow this IPO got caught up in the reverse merger scare and now provides one of the best growth opportunities around. It is rare to find a company growth around 50%, but still trading at 1x market cap ex cash.

LIWA on the other hand offers a solid play on the demand for recycling copper and producing copper products in China. While no legitimate fraud has ever been brought against LIWA, the stock has suffered alongside all the other china plays. LIWA also bottomed out in June at $5.19. The sector appears to have hit a tipping point during that month as the fear matched the financial crisis in the US during March 2009.

The risk remains that something under the surface exists that could take down these two stocks, but every day that passes increases the odds that both companies are legitimate businesses. If we are correct, both companies along with the halted Puda Coal (PUDA) will show up on the Top Performers list later this year.

Other weak stocks were Liz Claiborne (LIZ), Gafisa (GFA), and Foster Wheeler (FWLT). Both GFA and FWLT suffered from a fear that China and emerging markets would slow down resulting in less demand for their goods. LIZ on the other hand is a levered turnaround play in women's apparel that would suffer if the US entered another recession.

Top Performers
Rigel Pharma (RIGL) was the only significant gainer, but its 10% gain was not nearly enough to offset the major losses. No real news on the stock, but it recently hit 52 week highs possibly on speculation that the new arthritis drug will have successful Phase III results. Riverbed Tech (RVBD), Freeport-McMoRan Copper (FCX), and ICICI Bank (IBN) all had decent gains around 4%.

The model remains fully invested as we see significant growth opportunities once the emerging market inflation fear peaks and the European debt crisis passes. Both could possibly happen during July or take several more months. Either way, the remaining downside risk appears minor while the upside potential seems immense.

Disclosure: Long all stocks mentioned in client and personal accounts. Information presented should not be construed as investment advice. Please consult your own investment advisor. Please review the disclaimer page.


option trading said…
It makes me wonder how China is still amassing fortunes despite several failures in the stock market. I guess that's what a strong economy gives you - a large margin for error.

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