China Small-Caps: Don't Trade on Rumors

The following commentary comes from an independent investor as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

BEIJING (TheStreet) -- The China small-cap space is small and it seems that no one can keep a secret. I make it a point to never trade on "rumors," but at the same time, if there are enough rumors about a stock, it will often keep me on the sidelines (refrain from trading) until the truth comes out.

On Monday, I exchanged a few emails with a fellow investor who is very knowledgeable in the China space. He had done considerable research on Gulf Resources (GFRE) and was considering buying in to the stock. I am not overly familiar with GFRE, but what I did tell him was that I had heard a few rumors regarding an impending "hit piece" on the stock and that if he chose to invest, he should be cautious.

To my surprise, the hit piece came only 12 hours later, sending GFRE down by more than 30% for the day. I was glad to have the chance to save this fellow investor some money, and since he has already researched the stock extensively, I am evaluating the arguments of the short seller piece by piece to see if there is a buying opportunity.

GFRE has already issued a fairly standard, brief response and more is expected to be forthcoming. The company now trades with a market cap equal to its cash plus receivables, on a PE ratio of less than 2, so the market price is clearly giving full credit to the hit piece. To the extent that the hit piece is wrong, there could be decent upside.

In February, I wrote a negative piece questioning China Media Express (CCME) saying that I expected to see some sort of restatement. I was subsequently inundated with hate mail from vocal defenders of the company and its management. I told myself that in the future I would refrain from writing articles that were negative.

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