Playing Shanghai's Stock Market? China's Largest Dairy Shows the Risks

BEIJING (TheStreet) -- As China prepares to allow more overseas investors into the Shanghai Stock Exchange, the nation's largest dairy provided a reminder that there's plenty of risk in China's equity markets, too.

Stock analysts offered wildly conflicting opinions Tuesday in trying to explain why shares of dairy giant Yili Industrial Group nosedived Monday by more than 6% within a few hours, wiping out about $800 million in value. Yili officials had no comment. The stock closed down another 0.15% Tuesday.

The Yili story is a reminder for non-Chinese investors of the risks they face if they buy shares through the new Shanghai-Hong Kong Stock Connect program, which, according to mainland media, is likely to launch before Nov. 1. An official start date has not been announced.

The risks are many. In China, listed companies may lack proper corporate governance, and an Internet-supported rumor mill, operating independently of the state-controlled business press and largely hidden from overseas eyes, can affect stock prices. Analysts at UBS, for example, have warned clients who plan to buy Shanghai stocks about China's corporate governance issues.

The bottom line is that stocks listed on mainland exchanges such as Yili's can behave in mysterious ways.

After Monday's selloff, some stock analysts said Yili shareholders had been scared by a government corruption probe targeting a company executive. Although the probe was announced last month, these analysts said the market apparently didn't notice the executive's downfall until this week.

Other analysts said Yili's milk may have been the focus of investor rumors about an impending food-safety scandal. In 2008, Yili was one of several dairies whose powdered baby formula was found tainted with a toxic chemical that sickened and killed children nationwide.

Shenyin Wanguo Securities linked the selloff to "irrational pessimism" among shareholders, while Haitong Securities said several fund managers may have decided to sell the stock at the same time.

Overall, however, analysts said Yili has reported strong financials and was not the subject of any negative news reports in recent days. Shenyin Wanguo said Yili, which last year signed a trade deal with the Dairy Farmers of America cooperative, could one day compete against Nestle (NSRGY) .

Yili is one of more than 500 companies whose Shanghai shares will become accessible through the new stock exchange program to non-Chinese investors who open trading accounts with Hong Kong-based brokers. Currently, only certain foreign institutional investors are allowed to trade mainland equities.

The project, a cooperative initiative of mainland and Hong Kong regulators, will also let Chinese investors, for the first time, trade some Hong Kong stocks. If the project succeeds, foreign investors later may be allowed to trade mainland shares on the Shenzhen Stock Exchange.

 At the time of publication, the author held no positions in any of the stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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