Finding the winners in Chinese materials

The “dogs of the Dow” approach is well known in U.S. large-cap investing, but global traders can find endless ideas picking through the wreckage of the worst-performing emerging market ETFs as well. At the moment, the Global X China Materials fund (CHIM, quote) qualifies as the dirtiest dog at the table.

Image courtesy Saad Akhtar: http://www.everystockphoto.com/photographer.php?photographer_id=34229

Chinese construction worker

CHIM plays a viable role inside the Global X system of China sector funds, but the sad truth is that this particular sector — domestic Chinese companies that produce raw materials for industry — has not done well.

Year to date, CHIM is down a grim 12.5%, worse than any other non-leveraged fund focused on the BRIC group of Brazil, Russia, India and China and in the same suffering bracket as the Italy (EWI, quote) and Greece (GREK, quote) funds, down 9% and 16% year to date, respectively.

Problems in the portfolio are legion: a global steel glut, fierce competition with overseas miners and of course weak natural gas and other commodity prices.

And it’s not really a question of tinkering with the allocations to cut the losers. On average, CHIM’s holdings are down 9% so far this year, and with heavily weighted stocks like Sinopec (SHI, quote) posting even bigger losses, the portfolio as a whole ended up in sorry shape.

That said, the scattered winners have beaten the trend for various reasons and might be worth building into a “shadow” China materials ETF. Each is up at least 8% so far this year, but their collectively thin weight in CHIM means they’ve barely contributed 1% in positive performance to the overall portfolio — not nearly enough to overcome the losses.

China Rare Earth (CREQF, quote) is obviously a unique play, taking advantage of China’s virtual monopoly in the rare earth supply chain and the still-robust global demand for these key industrial materials. The stock isn’t all that liquid in the United States, but it does trade — and it’s up 20%.

Copper North Mining (CPNVF, quote) is less unique, but this stock has held up as a sort of “import / export” play on China’s legendary hunger for the red metal and the ability of overseas producers to feed it. The company is Chinese. The mine is in Canada. The stock is up 16%.

Gulf Resources (GURE, quote), like CREQF, has a deep competitive moat around its business. The company specializes in bromine salts and their derivatives, which are used in a wide range of industrial contexts. The stock is widely traded in the United States and shares have gained 8% year to date.

And Lingbao Gold (LGBOF, quote) leads the pack, up 24% so far in 2012 as a Chinese domestic play on the precious metals markets. Unfortunately, while there’s a U.S. ticker here, it rarely moves. It’s in here largely for informational purposes.

Pull CREQF and GURE out of CHIM as Chinese materials stocks with a unique competitive edge, throw out everything else, and you have a pretty powerful two-stock basket. It wouldn’t track the Chinese material sector, but there are times when simply following the benchmark is a great way to lose money.

Besides, domestic raw materials processing is a relatively small part of the Chinese economy anyway. The PowerShares Golden China fund (PGJ, quote) only allocates 6% of its assets to the materials sector, which means the entire group counts for less than cell network China Mobile (CHL, quote) as far as the managers are concerned.

As a crude proxy, traders who want a taste of China’s demand for raw materials could have been better served buying a giant miner like BHP Billiton (BHP, quote) and the two-stock basket mentioned above. Throw in CPNVF if you want a little extra copper.

Sure, BHP is down this year, too. But surround it with winners, and there’s simply no way it could have done worse than a straight allocation to CHIM. Give that “dog” some bite!

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