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.



) -- 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.


Harbin Electric

( HRBN) was a stock that was simply too obvious too ignore. I had considered shorting HRBN earlier in April, but once again rumors kept me on the sidelines. The rumors were that the MBO deal was going to get done, despite the fact that it simply couldn't get done from an economic standpoint.

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As a result, I refrained from trading until more concrete information came out. Shortly thereafter, the source of the rumors became obvious and a research note was released, with a subsequent 8K, seemingly announcing a bid for HRBN to occur on April 18. The notably odd wording of the 8K and the lack of a bid on the 18th confirmed to me that this was in fact a bogus rumor and I went short.

When I disclosed that I was short HRBN and why the MBO deal couldn't get done, I braced myself for an onslaught of flame mail. To my surprise, not a single reader responded with a defense of the company, the deal or the recent activities of management. Investors who are long noted that they are simply holding on for the buyout and were eager to discuss the probability of the deal actually happening, thoughts on potential timing, as well as the potential price action if there is negative news or if there is simply no news at all.

Investors who are short sent me loads of analysis including spreadsheets and company filings. The recent statements by the CEO suggesting a bid have put HRBN under a microscope, with numerous individuals devoting a lot of time to analyzing the company. I expect we will see some very detailed analysis of HRBN very soon.

The biggest rumor trade I have ever witnessed was on CCME following the release of the "Irrefutable Evidence of Fraud" hit piece put out by Muddy Waters. Muddy Waters provided what it felt was strong video and audio evidence of fraudulent activity at CCME and the stock price rapidly tanked by 25% to as low as $10.68. Almost immediately a source in China used various bulletin boards to spread the rumor that the material was entirely fabricated. This rumor went absolutely viral and immediately drove the share price up by nearly 30% with over $70 million in shares changing hands that day.

As with other rumors, despite the huge momentum in the stock, I chose to not act and I simply refrained from trading. Many people asked me my opinion of the "evidence" and whether or not it was fake. As for the "evidence," I did not find it to be particularly compelling one way or the other, and certainly not "irrefutable."

However I also questioned the rumor that the material was simply fabricated. At the risk of sounding naïve, I took the position that essentially no one with substantial ties to the U.S. would be so stupid as to produce and distribute completely fabricated evidence. In short, it was just another data point to consider. In any event, the "fabricated evidence" rumor successfully drove the stock to close at $13.09 and CCME is now being marked at $1 by brokers. I still wonder whether the originator of that rumor took the opportunity to simply dump his shares or whether the individual was indeed a true believer and is now sitting on a pile of $1 halted stock.

Small-cap stocks in general are more prone to be moved by rumors simply due to the fact that they receive less mainstream coverage than larger-cap stocks. This phenomenon is even more extreme with China stocks due to the fact that the average investor has no way to confirm the details on the ground. In my experience rumors are wrong about as often as they are right -- effectively it's a coin toss. While they can still have a significant impact on stock prices, the effect is typically short-lived and benefits only the one spreading the rumor.

But for those who really enjoy the rumor game, a fun place to browse is,

which declares that it provides "news before it hits the shelves." Enjoy, but be careful.

Disclosure: The author is short HRBN.

The author can be reached for comments at

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Rick Pearson is a Beijing-based private investor focusing on U.S.-listed China small-cap stocks. Until 2005, Pearson was a director at Deutsche Bank, spending nine years in equity capital markets in New York, Hong Kong and London. Previously, he spent time working in venture capital in Beijing. Mr. Pearson graduated magna cum laude with a degree in finance from the University of Southern California and studied Mandarin for six years. He has frequently lived, worked and traveled in China since 1992.