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I understand that shorts have to exist in the market to balance the equation, and let me first say that after having read “The Art of Short Selling” thoroughly a couple of times, I have the utmost respect for fundamental short sellers such as Kathryn Staley, Jim Chanos and David Einhorn.

China MediaExpress (CCME) is a Chinese company that I currently hold and is currently under heavy scrutiny as a fraud. Reports by boutiques specializing on shorts have been released, and while I must give credit to Muddy Waters for the work they have put in to their report, the main argument of the shorter’s report is that the numbers are “too good to be true”.

But I’m going to present a case for at least why the SEC filings are accurate.

Independent Auditor Required

The role of an independent auditor is crucial in protecting investors from dishonest management and

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While the leadership in the United States quibbles about whether we’re at war in Libya or we’re not (hint: We are), or whether we should reduce our deficit by 0.23% or not (that’s the $33 billion Congress is currently debating), the developing world continues to care less and less.

Take a look at the charts below, which I gleefully borrowed from a recent Bank of Japan report on commodities:

[Click all to enlarge]

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On 4/6/2011, Advanced Battery Technologies (ABAT) issued a press release responding to our research report titled “Advanced Battery Technologies (ABAT): The Most Egregious Chinese RTO.”

We present, side-by-side, excerpts from ABAT’s response and statements from their official filings. ABAT’s response contains numerous false and misleading statements which directly contradict its filings. We have provided links to these filings to make it convenient for the reader to verify our claims.

In our report, we noted that Chairman Fu now owns the company’s key subsidiary, which ABAT had previously claimed ownership of.

We wrote:

If the filings are accurate, the Chairman transferred ownership of the company’s sole operating subsidiary to himself without explanation or compensation. If the filings are inaccurate, then the company is guilty of misrepresenting itself as previously owning 100% of HLJ ZQPT.

Excerpt from ABAT response on 4/6/2011:

[HLJ ZQPT] has been owned by 16 investors, including Chairman Fu,

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The growth potential for China’s financial sector is undisputed, driven by strong growth and an under-penetrated, large population rapidly accumulating wealth (see here). In anticipation of this, investor valuation of Chinese banks put them into the top group of global banks by market capitalization. Critical to the development of its economy, China’s domestic financial sector has been nurtured cautiously, shielded from foreign competition and remains under significant regulatory oversight. For example, in banking, lending growth is targeted, lending rates must exceed a floor, deposit rates cannot exceed a ceiling, and all deposits and foreign currency must be transmitted via the banking system. However, this has not prevented a circumvention of letter and spirit of the rules.

A recent example of this

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One sure sign of a rising China is its more assertive stance in bilateral talks with the US. So last year, when US negotiators proposed that China help reduce the bilateral trade imbalance by opening up its markets to US exports, Beijing was ready with a proposal of its own: We’ll buy more American goods, if you scrap restrictions on high-tech exports. The US Cold War-style mentality, they argued, is the main thing standing in the way of more balanced trade.

Most experts consider the Chinese argument to be overblown. They estimate the annual amount of sales to China blocked by US export controls at US$2-3 billion. (The only hard number comes from a 2009 survey by the American Chambers of Commerce based in Beijing and Shanghai, which tallied US$560 million in actual lost sales). This barely puts a dent in China’s $252 billion trade gap with the US for

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China A-shares are traded in Shanghai and Shenzhen exchanges, and not available directly to foreign individual investors. China H-shares trade in Hong Kong and are open to foreign investors. The A-shares have historically traded at significant premiums to H-shares. This is because a bulk of the A-shares investors have been individual mainland retail investors who don’t have many other avenues to invest their savings; remember, their savings rate is estimated to range from 35% to 50%. These Chinese retail investors are of a speculative bent and tend to chase performance, resulting in wild swings like the bubble of 2007. Mainland retail investors were limited in their ability to invest in H-shares till the recent introduction of the Qualified Domestic Institutional Investor (QDII) scheme. Short-selling was not permitted in the mainland until recently, so there was no way to arbitrage by shorting the A-shares and going long the equivalent H-shares.

The

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Chinese RTO Puda Coal, Inc (PUDA) Chairman Ming Zhao transferred the ownership of PUDA’s sole Chinese operating entity, Shanxi Puda Coal Group Co., Ltd (“Shanxi Coal”), to himself in 2009 without shareholder approval according to official government filings. Then, in 2010, Zhao sold 49% and pledged the other 51% of Shanxi Coal to CITIC Trust Co., Ltd (“CITIC”), a Chinese private equity fund, for RMB245 million ($37.1 million).

Zhao then recklessly leveraged Shanxi Coal by borrowing RMB3.5 billion ($530.3 million) from CITIC at an incredibly high 14.5% annual interest rate (including fees) to finance the development of its coal mines. PUDA shareholders are completely unaware of these transactions that decimate the value of its U.S. listed shares.

Background – An Industry Facing Government Mandated Consolidation

According to PUDA’s 2010 10-K filing:

In order to improve production efficiency, workplace safety and to reduce coal mine accidents, the Shanxi provincial government issued

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Recently, Chinese small cap stocks have been assaulted from all sides with allegations of fraudulent and deceitful business practices. Rino International (RINO) was the first guilty party, but some attributed that to simple statistics; there are frauds in the United States as well.

More recently, China MediaExpress (CCME) came under scrutiny and despite a Big 4 auditor and investments from large market players, it seems the company will also be revealed as a sham. These two combined have shown that even Big 4 audits, investment from marquee firms and “legitimate” on the ground research can’t uncover fraud in every case. This week, two players of the Chinese short game have released independent reports on two different stocks. The latest targets are Duoyuan Global Water and Puda Coal.

Duoyuan Global Water (DGW)

Duoyuan was trading at $6.03 as recently as a week ago, but a report from infamous short Muddy Waters

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The manufacturing PMIs for March indicate that the pace of the robust global manufacturing sector has moderated. My GDP-weighted PMI for the major economies fell to 56.0 from 58.2 in February.

The pace of expansion in the U.S. eased slightly to a still robust 61.2 in March from 61.4 in February. The pace in the Eurozone also eased to 57.5 from 59.0 in February and easing was widespread. Greece, on the other hand, has seen a moderation of the contraction in its manufacturing sector. The U.K.’s manufacturing sector moderated relatively sharply from a robust 61.5 to 57.1.

As expected, the expansion in Japan’s manufacturing sector was halted as the impact of the terrible disaster is being felt. After registering its second consecutive month of expansion in February, the manufacturing PMI dropped from 52.9 to 46.4. The huge turnaround in Australia’s manufacturing sector in February came to an abrupt end in

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