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Blindly Shorting China Stock Yields Big Return

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

BEIJING (TheStreet) -- In March, Absaroka Capital (a firm I had never heard of) published a detailed report alleging fraud at China ShenZhou Mining (SHZ). Without bothering to read the report, I immediately bought as many puts as I could. Given that the stock was already plunging, I couldn't get many puts and I overpaid for what I did get, but the share price subsequently fell from over $5 to below $3, so it was a worthwhile trade. I fully expected SHZ to go below $2, but the volatility (i.e. price) of the puts was so high that, at $3, it made sense to sell the puts, so I exited.

Why would I go substantially short without even reading the report? Because even in the absence of fraud, this stock is so stunningly overvalued that it is simply destined to come back down to earth.

For a while, SHZ was mistakenly being viewed as a rare earth play (which it isn't) and the price exploded from $0.70 to over $10 in just a few months. When other rare earth stocks would have a big move in one direction, SHZ would follow suit. It was bizarre to watch, but I never wanted to fight the tape on it. By now everyone knows that SHZ is not a rare earth play, it is simply a fluorite company. However, some investors clearly seem to feel that fluorite might also represent an attractive play.

Yesterday, SHZ shot up as much as 10% after the company published a press release stating that China's Ministry of Land and Natural Resources would reduce the quota for fluorite production to 10 million tons. Clearly, a reduction in the quota will boost the price of fluorite and limit competition, thus providing a big benefit to SHZ. Then again, maybe not. From its most recent 10Q, SHZ expects that it will extract only 150,000 tons of fluorite ore in 2011. That is about 1.5% of the quota amount and demonstrates that SHZ is simply not even a real player in this market and will not stand to benefit even in light of the quota reduction.

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