Why I don’t buy Chinese stocks on AIM

Greg Rudd, the brother of the formerAustralianprime minister, once met a Chinese businessman who gave him someprudent advice.

"You tend to see the good in people, Mr Rudd", he started. "People like you. You laugh a lot. But you'll never make money in China with that attitude. You'll only be taken advantage of. People will trade off you. They won't pay you. Thenumber onerule of doing business in China is this; never trust a Chinaman. Why would you as a foreigner trust a Chinese businessman when we as Chinese don't trust each other?"

Now that advice is pretty close to the bone. But I've said it before in Penny Sleuth you have to be very careful when you invest in a Chinese company. The record of AIM-listed Chinese companies is simply awful. And with so many still coming to market, there is a real chance that many private investors will end up making some very expensive mistakes

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It might look good on paper

None of this has deterred UK investors from sinking their money in Chinese companies, and last week Herbalcos became the latest from the 'Land of the Dragon' to announce its intention to list on AIM, raising £15m in the process.

The business sounds attractive. Herbalcos has been around for 12 years since it was founded by Charles Liu. It sells its own detergent, shampoo and shower gels under the brand name 'Julang' ('Big Wave').

Many of these products include natural ingredients such as Oolong tea, which no doubt has mythical powers of good health, and the target customers are the swelling ranks of young Chinese women with a bit of disposable income. Herbalcos has grown its revenues and profit at over 60% a year and it's made a very healthy £7.1m profit in the first half of 2012 on revenues of £253m.

It sounds good, but will it do any better than the other Chinese companies to have listed on AIM? The record is, frankly, dismal. I struggle to think of one that has rewarded investors over anything other than a short period, and there has been no shortage of disasters, including solar panel maker Jetion Holdings, which has now delisted, and Bluestar Secutech (BSST), whose shares trade 88% below their 2007 issue price.

And yet they keep coming.

A new influx of Chinese companies

Since May, AIM has admitted five new Chinese stocks. LZYE GROUP (LZYE) runs infant schools in Hong Kong and wants to roll these out into China. KADA TECHNOLOGY (KADA), which supplies components and devices for the IT industry and consumer electronics, sees "a significant opportunity for growth in the wireless media business".

New Trend Lifestyle (NTL) is, to be fair, a Singaporean company that has opened Feng Shui shops in Shenzhen (taking coals to Newcastle, I think!). China Chaintek (CTEK) is one of the largest providers of logistics services to Chinese manufacturers of sports shoes and clothing. And Auhua Clean Energy (ACE) makes solar-powered water heating systems.

A word of caution

Needless to say the AIM admission prospectuses of all of these companies are enough to make investors lick their lips. But there are certain reservations that you should look out for.

Andy Chen of HanTime Capital, an advisor to AIM-listed Chinese companies, warns of a lack of transparency in management, weaknesses in corporate governance, the potential of a delisting, a lack of information available in English and, ominously, "the possibility of the management over-booking revenues from one big fanciful contract that never materialises".

When even the great Anthony Bolton is losing money for faithful investors in his Fidelity China Special Situations Fund, you know that you should tread carefully. The fund's chairman, John Owen, reports on a trip to the Chinese cities of Chongqing, Tianjin and Shanghai. "Our meetings with senior government officials, company boards and their senior management teams demonstrated the high quality of corporate leadership in China", he gushed.

But then many of these Chinese companies have been rather good at saying one thing, and doing another.

Before I go a word on gold.

Could gold hit $2,500?

It's been a royal few weeks for the yellow metal with the price now up to $1,764. And that is great news for gold miners.

I've said it before I think this is a great time to be buying gold miners. The recent US employment figures said a lot about the health of the US economy. And the euro area continues to stumble towards the next chapter of its crisis. The Fed has already announced QE3. And I think we could see a great deal more stimulus from there.

That means that gold could go a lot higher from here. And gold miners, who have been beaten down over concerns about rising development costs, could stage a pretty strong comeback from here.

That's why I've just tipped a gold miner in Red Hot Penny Shares. And I wasn't surprised to hear that Penny Sleuth readers have been flocking to sign up to the new newsletter from Simon Popple Metals & Miners. Simon tells me that he has 50% of his life savings in gold miners right now. So he must be a very happy man at the moment.

To find out more Simon and why he thinks gold could go to $2,500, click here now.

This article is taken from Tom Bulford's free twice-weekly small-cap investment email The Penny Sleuth. Sign up to The Penny Sleuth here.

Information in Penny Sleuth is for general information only and is not intended to be relied upon by individual readers in making (or not making) specific investment decisions. Penny Sleuth is an unregulated product published by Fleet Street Publications Ltd.

Metals and Miners is a regulated product issued by Fleet Street Publications Ltd. Your capital is at risk when you invest in shares, never risk more than you can afford to lose. Please seek independent financial advice if necessary. Fleet Street Publications Ltd. 0207 633 3600.