A month ago, Apple became the first technology company to join the Washington-based non-profit Fair Labor Association (FLA), a group of businesses and universities focused on improving working conditions around the world.

On February 13, 2012 Apple announced that auditors from FLA have started assessing the work environment at its final assembly suppliers, including Foxconn Technology Group (Foxconn) facilities in Shenzhen and Chengdu, China. A series of suicides at Foxconn plants in 2010 and two factory explosions in 2011, one at a Foxconn facility and one at a Pegatron facility, drew world-wide criticism for the working conditions at some of Apple’s partners’ plants. According to informationweek.com, in its September 2011 report, Students & Scholars Against Corporate Misbehaviour (SACOM) exposed various problems at those plants, including withheld wages, forced and unpaid overtime, exposure to harmful chemicals, and uncaring management.

Public responses to Apple’s decision to launch the investigation are mixed. Investors gave their thumbs up; Apple shares hit an all-time high as the company announced that it would investigate the alleged ‘sweat shop’ conditions in its supplier’s factories. However, the announcement has also prompted more outcries for Apple to find the solutions over the labor and environment problems at its products assembly facilities. ‘‘The reason why Apple is having this FLA inspection is not because they want to solve the problems; instead, it’s because Apple wants to get publicity and rebuild its positive image,” Li Qiang, executive director of China Labor Watch (CLW) said in a statement made after Apple’s decision. “What Apple should do now is to take action to solve the problems and improve the labor conditions in their supplier factories.”

Apple has made the right move as positive images, I believe the smart management of Apple understand, are not built on scandals. As a public company, Apple gets audited of its internal control over financial reporting and the effectiveness of its internal control system.  It may be time for Apple to apply the same internal control principles to its suppliers, balancing risks and controls.

The risks brought about by not tackling the dire working environments at its suppliers’ facilities are as follows:

*  Loss of public trust;

*  Loss of future investment funds;

*  Injury to the company’s reputation;

*  Increased legislation;

*  Violation of laws;

*  Default on a project;

*  Bad publicity;

*  Drop in the stock price.

Apple needs to create a control-conscious environment not only within Apple

but also at its suppliers’ facilities. The control environment is the control consciousness of an organization where people are committed to following an organization’s policies and procedures and its ethical and behavioral standards.

The followings are the action steps that would help Apple and its suppliers to encourage ethical behavior:

*  Set up policies and procedures, in this special case, labor standards at its suppliers’ factories;

*  Communicate up and down that the policies and procedures are important and should be followed;

*  Make suppliers fully aware of their responsibilities to enforce internal control measures;

*  Document key policies and procedures;

*  Send key employees of the suppliers to ethics and internal control training;

*  Evaluate suppliers not only on the quality of Apple’s products but also performance related to internal controls;

*  Take disciplinary or other actions for non-performance, discontinuance of contracts, for example;

*  Monitor the internal control system on an on-going basis, e.g., audits by Apple’s internal auditors or by external auditors like FLA;

*  Establish a whistle-blower system that provides a channel for disgruntled employees at Apple’s suppliers’ facilities to report violations of labor standards or vent their dissatisfaction or resentment on corporate unethical behaviors; and put control measures in place so that all misbehaviors are properly and promptly corrected.

Controls come with costs. To continue being successful, Apple needs to balance risks, controls and control-related cost. Fortunately, Apple’s suppliers like Foxconn also produce for other reputable technology companies like Sony, Nintendo and Hewlett Packard (HP). Apple is the only one who has been working with FLA, for which we should applaud. We ought to make sure that we do not punish the leader of righteousness (犯枪打出头鸟的错误.)

To conclude, to create a safe and healthy working environment in developing economies requires the work of a team of law makers, government regulators, organizations like FLA and CLW, and corporations from developed nations like Apple, Sony, and HP.

Huaqin Kim Chen, MBA

Financial Controller

CD International Enterprises, Inc. (NASDAQ: CDII)

431 Fairway Drive, Suite 200

Deerfield Beach, FL 33441

In the wake of this enormous demand and the expected increases in import activity, dealing with the legal aspects of contracting for the supply of iron ore to companies in China is critical to the success of such endeavors.  The following are some insights and experiences from a legal perspective with regard to doing this type of business that I believe should not be overlooked.

Customers drive the procurement process by indentifying required product specifications, expected pricing and payment terms, and quantities.  They also have standardized contract terms and conditions, warranty conditions, quality and inspection criteria and logistics requirements. While the significant business terms are common in most agreements across the globe, when dealing in China, customers use a variety of forms in Chinese and English that often times require significant expertise with individuals capable of working in both languages in order to finalize a contract to include all of the agreed on business terms in the proper form for all parties.

While standard terms are often not altered, business negotiators must work closely with legal counsel to negotiate only the issues that will have a significant business or legal affect on the successful completion of the contract. This requires experience in dealing with the supplier to know what accommodations they will accept based on prior business dealings and liability exposure.  Also, it is necessary for both the business negotiator and legal counsel to be sensitive to regional cultures and personalities. For example, the concept of guanxi is essential to the success of every business deal. Guanxi describes the importance of doing business based on personal relationships; it is one of the key social concepts that unite China culturally. However, guanxi can be interpreted differently by members of different generations, and can be accorded different levels of importance by those of the same generation. Individuals who are sensitive to the subtle cultural nuances can distinguish between essential parties and time-wasters and identify euphemisms to distinguish between good and bad reactions to negotiations. Once these key social concepts are understood and put into practice, the terms and conditions of the contract can be easily worked out to everyone’s satisfaction. The ability to understand and apply these cultural aspects of negotiating contracts with customers in China is critical and often very challenging without an experienced multi-cultural team.

Take-it-or-leave-it deals in China are culturally rooted — inexorable situations that force suppliers to take on some amount of risk. In these instances, it is important to recognize the difference between real risk and theoretical risk. The lawyer must put into perspective how contract terms will play out and much of this is derived from experience in completing actual transactions with Chinese companies rather than a theoretical approach.

One of the most significant aspects of an iron ore supply contract for delivery into China is that all iron ore imports are required to be inspected by China Inspection and Quarantine (“CIQ”) to confirm their weight, mineral composition and moisture content.  Results of this inspection which are used to calculate final pricing of a deal often times differs from inspections performed at the port of loading.  Consequently, this contract clause must be carefully negotiated to include a conflict resolution mechanism.  In addition, careful supervision by experienced personnel of the inspection process at all phases of the production and shipping process are essential to ensure the proper application of the agreed on pricing terms. For our transactions dealing with these issues, we have developed workable contract terms that are acceptable to all parties.  Also, we have experienced personnel stationed at each phase of production and the port of loading and the port of discharge in China to ensure that the expected economic results of each transaction are achieved.

We expect to ride the wave of the projected 7% annual growth in demand for iron ore in China using the experience of our worldwide, multi-cultural staff and tools we have developed to ensure success in completing supplies of iron ore to China.

Lazarus Rothstein

Executive Vice President and General Counsel

CD International Enterprises (NASDAQ: CDII)

431 Fairway Drive, Suite 200

Deerfield Beach, FL 33441

The SEC is scheduled to vote whether to adopt the 2500-page IFRS over the 25000-page GAAP for U.S. issuers. It is becoming evident for U.S.-based companies that adopting IFRS would be beneficial in an increasingly globalized world, where many countries have already adopted or is in the process of adopting IFRS. As companies think through the issues around IFRS, it would be beneficial to understand how IFRS would impact the role of Accounting Information Systems in a company. Here, I just want to briefly talk about the impact in the real estate industry from a strategic level and an execution level. Since real estate industry is global and competitive, it is vital for real estate executives to pay more attention to IFRS.

Strategic level: (a) IT infrastructure (ERP system, Data Warehouse): As many real estate companies expand rapidly, the accounting information system in these companies becomes harder to understand.  Many companies currently operate a mix of legacy accounting and ERP system, which leads to many errors in adjustments. Moving to IFRS provides a chance to streamline and integrate these separate systems. According to various needs of companies, major ERP transformation project may be designed in order to fully integrate IFRS into its systems and processes.

(b) Control environment as a result of IFRS: Earlier adoption of IFRS could be influenced to support the strategy of the company. As a global industry, real estate companies have many global operations and want to expand their international influence.  A carefully designed adoption process of IFRS will improve the possibility of identifying its value, which may show itself to public in some forms, such as reducing costs, standardized reports, and enhanced controls over foreign sub branches.

Execution level: (a) capturing of data/information: With the rapid expansion of real estate industry, the needs for IT are extensive at the same time. From leasing data to depreciation schedules to tax recordkeeping to recording the fair value of investment properties, there’s plenty of information for real estate companies to keep track of. The single consolidated system is no longer competent for the complicated situations. The real estate companies have launched  planning or engaged in major IT initiatives by integrating separate systems into comprehensive ones to better capture data needed in the transactions. The benefits of efficiency, productivity and compliance are potentially significant to companies within the real estate industry. During this integration process, the factor and impact of IFRS must be taken into consideration. This process should not only take into account of the present needs, but must be able to handle any future needs. As we all know, reporting under IFRS will be become  inevitable. If IFRS conversion is not considered during the upgrade process at the very beginning, it may cost a lot of time and money to compensate in the future. Also, a change in accounting standards will probably require modifications to the financial reporting systems in order to accommodate information not currently required under GAAP. It may also be necessary to revise some IT systems related to business processes, especially those that are relied on accumulated data that are  entered into the financial accounting systems.

(b) Storage of data/information: Data drives many business decisions in today’s enterprise, and finding ways to better manage that data and use it to accelerate business growth is a key challenge for many real estate companies. Real estate industry is concerned with conquering the data storage challenges. Under IFRS reporting, various data storages can be separated, and reporting can support multiple analyses at any time for any date. To some extent, this simplifies the way that companies manage their data storage. Some ERP system, such as Oracle, combines industry-leading performance and efficiency with a rich series of integrated data services and storage management software that is included at no extra cost. Never before has storage been so flexible, so powerful, while also helping to reduce operating costs, making it the perfect storage platform for mission-critical deployments in the modernized datacenter.

Also, during the early period of conversion from GAAP to IFRS , companies still have to generate IFRS-compliant comparative financial statements, which mean that companies may need to run two parallel financial statements during the year of the conversion. Therefore, these companies must consider the following questions, such as whether the system can handle parallel processing, does the company have data storage and memory capacity to keep all the financial information required, does the financial department have the capacity to enter data into two system, does the financial department have access to the level of data required to run financial statements using various accounting standards. Thinking about these challenges, companies need new technologies to overcome shortcomings.

(c)Pervasive and application level controls: Pervasive controls protect an organization’s resources, ensure that business processes operate as planned, assist in the achievement of an organization’s objectives, and ensure effective IT operations.

Changing to IFRS may probably influence the hiring, training, compensation practices and policies of the real estate industry. First, the company may want to add a personnel inventory to the IFRS work plan to have a clear idea of the number of financial staffs who are currently familiar with IFRS. To train the other staff with the knowledge and usage of IFRS, the HR department must first recruit someone knowing these kinds of information. Second, as is known to all, real estate companies usually pay their sales representatives commissions based on sales or rental revenue. But revenue recognition rules are different between IFRS and GAAP, which means that sales or rental revenues under GAAP might be treated in another way under IFRS. Furthermore, some other compensation in real estate industry may be based on net asset value, which is also handled in a different way between IFRS and GAAP. Finally, many real estate companies calculate bonuses for top executives based on profits. In many conditions, using IFRS for reporting may change the amounts. The HR department may also need to revise the executive compensation plan.

Many companies outside US have already adopted IFRS, and there is more and more evidence showing that US companies will also use IFRS instead of the current GAAP standards. If most of the companies over the world accept IFRS, it becomes easier for company to compare with each other, thereby achieving the goal of global integration.

Xiao Zhou
Accountant
China Direct Industries, Inc
431 Fairway Drive, Suite 200
Deerfield Beach, FL 33441
Phone: 954-363-7333
Email: info@cdii.net

CDII Official Website: cdii.net

Facebook: https://www.facebook.com/CDII.ChinaDirectIndustriesInc

Before the type of law is narrowed in scope and breadth, to assist in researching, you will need to understand the structure of the government you are dealing with.  Is it a Civil law country?  A Common law country?  Perhaps mixed?  This information will help you decide, (1) where to find the information and, (2) what law is binding in the specific international jurisdiction.  It is important to note however, that certain jurisdictions’ courts are very inequitable, and often times unconscionable with their rulings and or decisions.  Therefore, specific research on the jurisdictions’ courts should also be addressed with a particular eye on the country’s economic, social and political landscape.  This can be completed by researching specific case law and court rules on the jurisdictions webpage or jurisdiction specific database software.  Despite the fact that the website may be in another language, there are tools today which can translate the source code of the website.  This effectively allows the internet user to see the webpage in its original form fully translated.  This can be conducted automatically with an internet browser such as Google Chrome.  Case law and Code research are extremely beneficial in a common law based, or case law based judicial system.

After conducting the initial governmental research, a logical next step is to determine what type of law you are dealing with.  There are different types of international law.  The first type is Public international law which governs interactions between states, between states and international bodies and between international bodies themselves. This law derives from international agreements, customary law, judicial decisions and academic writings.  Private international law deals with relations between individuals over state boundaries and it is regulated by treaties or domestic law.  Most contracts and recognition of judgments are governed by this type of law.  Corporate attorneys engaging in international transactions should be very familiar with this type of law as it pertains to the validity of contracts and principals of comity, or international reciprocity.  Supranational law encompasses regional agreements (like the EU) where the laws of nation states may be invalidated if they conflict with the laws put forth in the agreements.  Foreign law is also very important as it contains laws such as constitutions, statutes, regulations, and court decisions.  It does not have effect outside the nation, however; some foreign law may regulate foreign entities.  Foreign law is also very important when dealing with international trade because, when doing business in a foreign county, one is governed by the law of the land.  This will give you a fundamental and comprehensive starting point in finding the answer to your legal question.

After this information is obtained, you must consult the sources that are most applicable to your specific legal issue and specific type of law.  Similar to legal research in American jurisdictions, the best place to start is a secondary source.  A secondary source is a compilation of various legal issues and laws, which help guide you to the correct sources and law. Generally a secondary source enables you to locate primary sources posted elsewhere.  Primary sources are the original source of law, the law you want to use when analyzing a specific legal question. A great source, often found via the internet at a relatively low cost is the Foreign Law Guide: Current Sources of Codes and Basic Legislation in Jurisdictions of the world, T Reynolds & Flores.  “This site is [designed] for the practitioner, scholar, and researcher and provides essential information on primary and secondary sources of foreign law—what it is, where to find it, and how to use it. It contains information on more than 170 jurisdictions from major nations to crown colonies, semi-independent states and [supranational] regional organizations. The work is comprehensive in content and global in scope and contains exhaustive links within the work to many URLs on the world level.”[1]  Furthermore, this source provides various language translations of most entries on the site.  The cost is $2,075 dollars per year.  Other sources readily available are Globalex, http://www.nyulawglobal.org/globalex/index.html.  This website has various countries guides which are available, in addition to guides on international and comparative legal research topics which encompass public, private, foreign and supranational law.  Most information on this site is available for free. Another research website is FLARE: Foreign Law Research Guide, http://ials.sas.ac.uk/library/guides/research_guides.htm#flare. This website is a collaboration between the major libraries collecting law in the United Kingdom and various other jurisdictions.  Lastly, perhaps the most beneficial source is LLRX Comparative and Foreign Law Resources Center, http://www.llrx.com/category/1050.  This site includes research guides and directly or indirectly links you to various other legal resources such as the following large databases, (1) World Legal Information Institute, http://www.worldlii.org, (2) The Law Library of Congress,http://www.loc.gov/law/help/guide.php and (3) The Law Library of Congress, Global Legal Information Network, http://www.glin.gov/search.action. It is substantially likely that secondary sources will lead you to the right set of laws, most often found via the World Wide Web.  In developing countries it may be more difficult; however, there are alternatives to finding out the applicable information.

Today current technology is increasing at astronomical rates.  This technology allows a user to contact any location across the world with an internet access at relatively low costs.  Generally contacting another country requires diverse linguistics but often times individuals working within the governments speak English.  In addition, the information can be translated instantaneously if sent electronically though Skype or translation programs.  Contacting local municipalities or local companies who specialize in the legal issues which you are seeking may be extremely beneficial especially in developing countries where the information is not readily available on the internet.  If you cannot get in touch with appropriate persons or you feel the information lacks legal credibility, the next best step is to contact local counsel to assist in the matter.

There is no substitute for being on the ground in the region you are conducting business.  Speaking with locals and establishing connections in the specific jurisdiction enables you to communicate face-to-face with local municipalities to learn the law from the source.  However, with evolving technology there are other alternatives which can save you time and money which can be the life blood of a new or existing international business. Of prime importance, however, is keeping a keen eye on the countries’ political, social and economic differences in relation to your legal question.

China Direct Industries, Inc.

Since late 2010, many China-based U.S. listed public companies have undergone a veritable swoon – one brought on by a confluence of company financial restatements, auditor resignation, delisting, trading halt, accusations of fraud, fears over the Chinese economy, and extreme volatile capital markets worldwide. This swoon has induced both pain in the pocketbook and the theft of personal sanity of many investors as each is left to consider whether the current systemic depression in the prices of China-based U.S. listed public companies is indicative of the true problem: fraud, or is it rather the result of short-term noise that is hiding the true value of these companies.

Let us look at the positives:

Over the past thirty years, China’s economy has grown over 250%. China’s GDP has grown at an average annual rate of nearly 10.0% reaching as   high  as 14.2%; the per capita GDP grew at an average annual rate of 8.1% and reaching as  high as 12.0%. Furthermore, the emerging middle class in China has grown from 65.5 million in January 2005 to 80 million in January 2007 and is forecasted to be 700 million by 2020. According to estimates by Deutsche Bank’s Chief Economist for Greater China, China will be the world’s largest economy in the world in a decade.

China’s budget deficit is mild compared with that of the Western countries such as U.S.,  and many within the European Union. Its population is much younger especially when compared to Japan and its economy is growing much faster.  In addition, China’s primary educational system is really good, and so is its infrastructure such as roads, bridges railroads, and communications and they are getting better each day. Furthermore, the Chinese have strong work ethics, and its government is determined to make China a world-class competitor.

The worldwide economic crisis of the past three years proved to the world that the economy China has been developing over the past three decades is both strong and resilient. . China held up better than most developed countries. In 2009, for example, China’s GDP increased 10.7 percent. That compares with a growth rate of 0.1 percent in the U.S., shrinkage of 3.9 percent in Japan, and shrinkage of 2.4 percent in Germany.

Many of the Chinese stocks trading in the U.S.  are shockingly undervalued.  If you want to make money on China while minimizing downside risk, the best way is to  invest in China through buying Chinese public companies that are listed on U.S. stock market exchanges.  Of course, due diligence is a must before you invest these companies.   I believe it’s wise  for U.S. investors to put a portion of their assets in China. I suggest 10 percent to 15 percent for most investors and 20 percent for those with higher risk tolerance.

There are over 700 Chinese firms that have listed on U.S. exchanges and they vary widely in terms of size and sector. These firms include the online search giant Baidu (NASDAQ: BIDU).  These Chinese companies also notably vary according to the means by which they achieved listings on U.S. exchanges. Some, such as the online travel services provider Ctrip (NASDAQ: CTRP), was brought public through the traditional IPO process by notable Wall Street firms. Companies such as these hold vaunted statuses and command rich valuations. Countless other firms came to market through a process known as a reverse merger – a transaction whereby a shell company – an incorporated legal entity that is already listed on the Over-the-Counter Bulletin Board, merges with the Chinese private entity.  The result is that the Chinese company is effectively made a publically traded entity at a much smaller cost than a traditional IPO and much more quickly. After become publically listed, the Chinese company can then raise capital through a share offering or a Private Investment in a Public Entity (“PIPE”) transaction.

What do you need to look for before you feel comfortable investing inChina-based U.S. public companies?

First, does the company have one of the top 15 PCAOB registered auditing firms based in the U.S., with offices or operations in China as auditor?  The key is that the auditing firm must be based in the U.S., because PCAOB is then able to audit the auditing firm once every three years.  The Big Four auditing firms have their Chinese subsidiaries in China to perform audit for China-based U.S. public companies, however, PCAOB is not allowed to audit their work paper.  In addition, you need to check if the auditing firm has its own offices or operations in China.  If not, it is more likely that the auditing firm has to hire a third party, often a Chinese accountant, to do field auditing.  The auditing quality is questionable.

Second, does the company have a reasonable business model?  You should carefully read the company’s 10Q and 10K to understand the company’s business.  The most important is to understand why the company is making or losing money.  Use common sense, if it is just too good to be true, just walk!

Third, does the company have adequate investor relations presence in the U.S. such as U.S. representative (not IR contact), U.S. offices, U.S. website, up to date press releases, road shows and conferences, English speaking CFO, social media, and so on? These particular details can tell if the company is serious about its shareholder value.  A professional website with detailed information in English and contact links with individuals that will actually respond are very important.

Fourth, does the company have sales contracts with U.S. corporations, multinational corporations or corporations outside of China?  Because those contracts and the income they provide can be confirmed. A U.S. firm utilizing a Chinese company’s products also provides some indication of the quality of the goods and services being provided. The more contracts outside of China, the better you should feel.

Fifth, is the company willing to provide its Chinese tax return filings including valued added tax, income tax and its SAIC filings? Basically, these filings in China should be consistent with its SEC filings.  Keep in mind that some China-based companies may have  exporting businesses through their offshore entity, in which case, their Chinese filings may vary from their SEC filings.

James Wang, Ph.D.

Chairman and CEO

China Direct Industries, Inc. (NASDAQ: CDII)

431 Fairway Drive, Suite 200

Deerfield Beach, FL 33441

Phone: 954-363-7333

Fax: 954-363-7320

Mobile: 561-212-5029

Website: www.cdii.net

SEC

As the latest official stance, on November 9, 2011 the SEC approved new rules to toughen the standards that companies going public through a reverse merger must meet to become listed on the three major U.S. listing markets NYSE, Nasdaq, and NYSE Amex. The rules was adopted against the backdrop that the SEC and U.S. exchanges in recent months had suspended or halted trading in more than 35 companies based overseas accused of a lack of current and accurate disclosure about the firms and their finances, many of which were structured through reverse mergers. In June 2011, the SEC issued an investor bulletin warning investors about reverse merger companies.

The adoption of new rules was due to the pressure of marketplace. Since summer 2010, the trustworthiness of foreign reverse merger companies, most of which are Chinese firms that substantially operates in China, have been questioned by some independent research firms such Muddy Waters and Citron Research. Though the targeted companies are questioning the validity of the information source of these analyst reports, the plausible arguments and concerns raised by these reports have effectively created public distrust on the reverse merger structure and caused a wide stock price plummet of China-based listing companies for months.

The new rules prohibit a reverse merger company from applying to list until the company has completed a one-year trading in the U.S. over-the-counter market or another regulated U.S. or foreign exchange following the reverse merger and all the required disclosure are current and accurate in addition to the maintenance of minimum share price for at least 30 of the 60 trading days immediately prior to the listing application and the exchange’s decision to list.

Many Chinese stock analysts argue that the scrutiny should be on the specific companies rather than the reverser merger structure as that could hurt or put on hold normal capital formation for some small foreign companies. Many believe that SEC’s new rules have officially closed the window for a period of maybe one year or two for new Chinese companies in pipeline to enter the U.S. capital market and created a dilemma for current listing companies on market.

Challenged by the tightened SEC rules and marketplace distrust, the essential pressure that Chinese listing companies including those with well-performed finances are facing is to fight back investors trust and confidence through transparent, effective, full-access, proactive communications with investors and take tougher measures to strengthen corporate governance and financial management.

Investors still welcome listing companies with well-performed financial fundamentals. For instance, Qihoo 360 Technology Co., Ltd. (QIHU.NYSE) listed in March 2011 was targeted by Citron Research this November has seen a plummet of stock price during the month. However, the company Q3 financials filed on November 17 was above analyst estimates with quarterly net income rose to $11 million from $3.8 million in 2010 and revenue rose to $47.5 million from $15.5 million a year ago. The trading prices immediately rebounded that day.

For the other direction, some listing companies are considering privatization. On November 22, 2011 Chinese interactive-media company Shanda Interactive Entertainment Ltd.  (SNDA.Nasdaq) announced the agreement to go private and pay stakeholders $41.35 an American depositary share, which values about $2.3 billion. The company in October received the offer from its Chairman and Chief Executive Tianqiao Chen that valued the company at $41.35 a share, a premium of $9.18, or 29%, over its Oct. 14 price. The privatization pursued by the companies like SNDA is commonly regarded as a calculated and temporary retreat from marketplace and the prelude to a return with a brand new public offering after the completion of reorganization and business improvement.

So, it is time to turn right or left. Stay or go? Chinese listing companies at the crossroad have to make decision now.

Jade Ye

Account Executive

China Direct Industries, Inc. (NASDAQ: CDII)

431 Fairway Drive Suite 200

Deerfield Beach, FL 33441

Website:www.cdii.net 

Corporate Social Media Sites
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LinkedIn: http://www.linkedin.com/company/cdii

China Direct Industries, Inc.

As part of my position at China Direct Industries, I oversee the public and investor relations component of our company, as well as a number of our publicly traded China-based advisory services clients.  As you can well imagine, that has me travelling quite often to investor and corporate conferences across the globe.  Very recently, I attended a conference in New York, sponsored by a major law firm, centered on the topic of China.  This conference was unique in many ways, but most strikingly so because of its main topic: fraud. The reason I found this topic so striking was that, for the last four years, when it came to China, the conferences were more about growth, the opportunity of a lifetime, and the sheer power of numbers that China possesses compared to the rest of the world.  It made me think about what a difference the last nine months has made for China stocks in the U.S. As I was watching some noted China bears go at it with some few remaining China bulls in a white collar Jerry Springer-like format, I could not stop my mind from drifting nostalgically into the past when I worked in the brokerage industry.

Having spent the better part of twenty years in the investment banking and brokerage industry, I have heard a great many clichés.  Classic sayings like “The trend is your friend” or “Bulls and bears make money, pigs get slaughtered” could be heard every day as brokers talked to their clients or managers tried to pump up the sales force. But, my favorite cliché, which I first heard from a retail sales manager who still remains one of my closest friends, was a bit more obscure “You should always buy your straw hats in winter”.  Maybe it struck a chord with me because I lived close to, dare I say it, the “Jersey Shore” and know that, come the day after Labor Day, all the beaches are free and every straw hat, umbrella and beach towel sold at the local shops gets marked down 40%, 50% and 70% as each week goes by.  Is investing with that philosophy the key to long term success? By itself, of course it’s not.  Nothing takes the place of doing your homework on individual stocks, but buying companies in a sector that is very out of favor can lead to huge returns over time.

History gives us many examples of hot sectors that have gone bust only to rise up again even stronger to handsomely reward the straw hat buyers willing to buck the trend.  In my past, I can vividly recall how the “Dot Com” sector went from “wave of the future” to “four letter word” in the span of six months in the year 2000.  High profile telecommunications companies like Lucent and World Com, which grew tremendously servicing that sector, turned out to basically be “cooking the books” to use another industry cliché.  Back then, every internet company and most tech companies were “a lie”, “a fraud”, and “going to zero”.  Sounds familiar, doesn’t it? Many internet companies did go bust or were swallowed up by larger companies for next to nothing, but many also far outperformed the market in the next 5 to 10 years.  Two that come to mind for the savvy straw hat buyers of 2001 were Captain Kirk’s Priceline, trading as low as $1.80 from a high of over $100 in 2000 (prior to a 1 for 6 reverse stock split), and a debt ridden online bookstore trading as low as $5.51 down from over $90 in 2000. I think its name was Amazon.com.

Closer to the present, when thinking of “fraud” or “worthless”, my mind settles on the banking industry and auto companies like GM.  The near collapse of our financial industry created a panic that briefly ushered in a new penny stock era with the likes of Citibank, Bank of America and Ford as its new ambassadors (all of which were trading close to a dollar or two a share).  In fact, there were so many cheap straw hats created by the panic of 2008 that the straw hat buyer did not even need to be that savvy to make a boat load of money in less than two years. And, for the record, I did make money on a few shares myself.

Sometimes it just gets too easy when a sector is hot, resulting in shoddy due diligence, overvaluation and sheer greed taking over.  The China sector is no different, and the problems now surfacing in accounting irregularities and, in several instances outright fraud, have certainly raised the risks for investors to very high levels.  But, sheer panic makes the pendulum swing too far the other way.  When it does, a company like Harbin Electric (a straw hat I happened to make some money on) traded at a 50% discount to an all-cash takeover offer of $24 per share.  The fact that this offer was vetted by several major law firms and financial institutions was lost in a high profile short-long tug of war.  Harbin did get taken over for that cash price in November of 2011 despite the widely publicized assurances of several major short sellers that it definitely would not happen.

So, as my mind wandered back into this conference and I listened to some really smart people make mostly negative comments about pretty much all China-based companies, I kept wondering if I had enough room in my closet for a few new hats.  While what has happened in China is very unsettling in terms of accounting irregularities, fraud and, more importantly, the difficulty in pursuing legal remedies where improprieties exist, it does not mean that every company in China is “a fraud”, “a lie”, and “going to zero”.  To the contrary, China is the only major country with a surplus that is still growing at a good pace. Compare that to the Euro Zone or even our country.  I guess that means to me that I will do a great deal of homework on China stocks and follow the actions of my favorite fictional straw hat buyer, Mr. Potter from the classic movie “It’s a Wonderful Life” who bought when others were in sheer panic during the Great Depression.  And guess what? He certainly wasn’t the nicest man in the little town of Bedford Falls, but he was by far the richest and he kept getting wealthier all the time!

Richard Galterio

Vice President

China Direct Industries, Inc. (NASDAQ:CDII)

431 Fairway Drive, Suite 200

Deerfield Beach, FL 33441

Office: 954.363.7333 ext. 316

Toll-Free: 877.680.7333

Fax: 954.363.7320

Email: richard.galterio@cdii.net

Website: www.cdii.net

Corporate Social Media Sites
http://twitter.com/ChinaDirectCDII/
http://cdiichinadirect.wordpress.com/
http://www.linkedin.com/company/cdii

Subsidiaries Websites.
http://www.magnesiumgroup.com/
http://www.cdiitrading.com/

China Direct Industries, Inc.

TV personality and ex-hedge fund manager, Jim Cramer, although difficult to listen to for long periods of time, stands by a certain motto that I’d always found to be right-on-the-money. Occasionally as Cramer wraps up his afternoon show, Mad Money, he concludes by telling his audience, “Do your homework people! It’s the only game in town.”  All the “elephants” you’ve ever read about in Forbes, Fortune, etc., would NEVER invest 10 cents into a project without first performing a thorough investigation. That being said, the industrial commodities market is a unique one, and within this marketplace, you will find that every commodities trader has a special relationship with the term “D.D.”

Homework (more commonly referred to as Due Diligence) is everything, especially in the commodities markets. D.D. is the solution to everyone’s problems; it is the beating heart which allows for the healthy life of any long-term contract, whether the cargo of this contract be iron, cotton, or drinking water. Do not allow yourself to become too complacent. Aside from the most rudimentary of D.D., such as an entity’s corporate & tax-related documents and operating licenses, there exist several other factors which are equally paramount to a deal’s success, such as logistical solutions, network circles, and/or personal experience. Just as fundamental D.D. can be viewed as the beating heart of a transaction, logistical solutions serve as the ‘veins’ and ‘capillaries’ of such a transaction, allowing for the smooth flow of cargo from nation to nation.

Obviously the term ‘homework’ can refer to many things within the corporate world. Researching a particular candidate for a job opening, reading psychology-related books about negotiation, preparing for an upcoming interview, and/or studying case law can and should be deemed ‘homework’ by the hungry entrepreneurs of this world; however, in the industrial commodities markets, D.D. is exceptionally vital. If you work as a bank teller, for example, you may be able to slide by without having to do too much ‘homework’. If you trade commodities and disregard D.D., you are toast.

With current market levels being so volatile, many (impulsive) traders have found themselves in ‘tight spots’, while other, more patient traders have experienced nice profits at the expense of the reckless . Are the impulsive less-effective than the patient, at least when it comes to market forecasting? Perhaps. However, there was a time when these two men sat on the same level playing field, and it was the direct result of their recklessness/patience which landed them where they are today.

Similar to the moral of the old children’s story “The Tortoise and the Hare”, the factor of speed, although an occasional asset, is not the answer to profits and success; diligence is.

Alex Friedberg

Vice President, International Logistics
CDII Trading, Inc.
431 Fairway Drive, Suite 200
Deerfield Beach, FL 33441

Corporate Website
http://cdii.net/

Corporate Social Media Sites
http://twitter.com/ChinaDirectCDII/
http://cdiichinadirect.wordpress.com/
http://www.linkedin.com/company/cdii

Subsidiaries Websites.
http://www.magnesiumgroup.com/
http://www.cdiitrading.com/

Sure there are China naysayers out there. Their argument is that China banks are riddled with bad loans from real estate projects gone sour, and nobody truly knows how bad it is because China is not transparent.  China’s had this problem before with its big four government owned banks and basically did what the US government did by creating an entity to buy up all that bad debt in order to keep the big four’s books squeeky clean. How bad is the real estate and credit bubble in China? Agnes Deng, the portfolio manager at the closed-end Greater China Fund (GCH) run by Baring Asset Management Asia Ltd. in Hong Kong says China’s non-performing loans are actually quite low.  The banking crisis that the bears are forecasting will take China down from its pedastal may never prove valid.

“From where we sit here in Hong Kong, I personally don’t believe there is a credit or asset bubble in China,” Deng told Forbes recently.

“A lot of money has been going into construction and that kind of debt is heavy in the overall banking system. But it is reasonably OK. In terms of property, we don’t believe there is any national bubble for the property sector. We do see it in the first tier cities like Beijing and Shanghai, but notice that the overall demand and economic growth in China has been quite steady over the last many years and that growth will continue to carry out the momentum we have seen in the last two to five years. So we will eventually adjust to some of the oversupply in construction projects in the pipeline,” she says. “I wouldn’t bet on a housing developers crash or a broadbased asset bubble in China. The leadership in Beijing should be able to solve this issue.”

China’s central government has been forcing a slowdown of the national economy. Inflation remains high, mostly due to consumer demand, a stronger currency, higher incomes, and imported inflation from commodities. However, the government has taken a special interest in reducing demand for residential construction and existing properties.

If the government is successful at keeping inflation in check, then China’s growth might not be in the double digits, but investors expect it to remain well above 7%.  Housing will trend higher, but grow below inflation levels of 5.5%.  A gradual appreciation of the currency, the yuan, and higher incomes is making Chinese consumers richer. It’s a homogenous society, so if one Chinese person likes Twinkletoes shoes, then a million more are sure to like it, too, says Deng.

Her $443 million fund is overweight real estate, but underweight financials compared to the benchmark Russell Greater China index. She holds China Construction Bank — their biggest holding currently — and the Industrial and Commerical Bank of China, both state owned. Even though banks are an underweight for the fund, Deng thinks China banks are solid assets for long term investors.

China Construction Bank’s loan to deposit ratio is less than 80%, so it is not leveraged at all, she says. For banks, if you have 10 dollars and lend out 75 cents, you’re conservative. If they have 10 dollars and lend out 100, they’re Goldman Sachs.

The People’s Bank of China has been requiring banks to keep 20% of their reserves in central bank reserves as a guarantee. China’soverall non-performing loans (NPL) is below 2%, even though the market is thinking the numbers are higher because some government development projects have gone sour.  “If you include those projects since the financial crisis of 2008, then the NPL ratio is still going to be below 5%,” she says, cheerleading for China’s financials. “As an aggregate amount, five percent is quite big. Computed with the overall loan book that the China Construction Bank or Chinese banking overall has, then it is really quite small. China’s banking regulators have done a good job getting the financials to deleverage quickly after 2008.”

Deng’s take on China has paid off. The Greater China Fund’s sales growth percentage as of March 31, 2011 was 10% compared to a sell-off in the China fund category averages of 22%. Deng’s fund’s long term earnings percentage is 20.3% compared with 16.3% for the Russell Greater China index and 15.9% for the category average.

Year-to-date, the Greater China Fund has outperformed the iShares FTSE Xinhua China 25 (FXI). Both are down on the year thanks to their real estate and banking positions, but the FTSE China is down 1.7% as of July 31, 2011 and GCH is down 1.1%. Over the last 12 months, GCH has clobbered the FTSE China, up 11.4% to the iShares’ gain of 2.7%. Deng’s fund has even outperformed the Matthews China Fund (MCHFX), up 8.7% and another closed-end competitor from Boston, the China Fund (CHN), which is up 6.3% YTD. Since the fund launched in the early 1990s, its beat its benchmark. It’s up 9.1% as of June 30, 2011, while the benchmark Russell Greater China is down 0.5%.

Besides real estate, the fund is also overweight telecom and technology. On the telecom side, Deng likes China Unicom (CHU) because it is the only wireless mobile provider that uses the iPhone and iPad, and Apple (AAPL) dominates China’s tablet market.

“China Unicom sells iPhones and iPads and that’s a big plus for that stock. China Mobile, China Unicom and China Telecom all use different technology, so Apple is just China Unicom,” she says. “China Mobile is 3G and uses a home grown technology that the overall big brand names do not use. China Mobile ends up losing market share because of that and China Unicom gains market share. We still like China Mobile because it trades at a discount, but China Unicom is more of a growth story and that is the main reason why investors invest in China…for growth.”

On the tech side, it’s SINA Corporation (SINA) all the way. Sina’s an internet and social networking powerhouse that runs the weibo platform, a China microblog that has more users nationwide than Twitter has worldwide.

“China’s internet penetration is still low. There is a long way to grow. Many China internet stocks have been quite expensive, like Tencent Holdings a few years ago it was around $2 to $3 and now its around $140. Baidu (BIDU) has always been expensive, but they just keep reporting amazing earnings with upside and that has them trading at fifty times p/e because they are growing phenomonally.”

Not too long ago, the Chinese government, in its attempt to lend a fig leaf to its offshore political rival, Taiwan, allowed for Chinese nationals to travel to the island. Politically, the permission slip is like Washington letting Americans travel to Cuba and bring back cigars. While Chinese aren’t returning from Taiwan with cigars, they are returning with Taiwan’s signaturepineapple cakes. As a result, says Deng, Pineapple cake sales are up 40% year over year because of China demand. China’s growing relationship with Taiwan is also good for Taipei listed companies.

What’s so great about China is basically what’s been great about China for the last 10 years. When 1% of the population earns enough to buy an automobile and trades in a bicycle for a Buick, it makes China General Motors’ biggest market; it drives the fundamentals behind oil futures over $100 on average in the years ahead. When the same amount are eating more, it drives the price of soybeans as much as the weather and keeps farmers from Iowa to Parana, Brazil with a reliable customer.

The International Monetary Fund expects China to grow around 9.1% in 2011.

Kenneth Rapoza, Contributor

Covering Brazil, Russia, India & China.

http://www.forbes.com/sites/kenrapoza/2011/07/31/whats-so-great-about-china/2/

http://cdii.net/
http://twitter.com/ChinaDirectCDII/
http://www.linkedin.com/company/cdii
http://www.magnesiumgroup.com/
http://www.cdiitrading.com/
http://cdiichinadirect.wordpress.com/

In this article, via an analysis of the investing activities of the world largest fund managers, managing between $100 billion and over a trillion dollars, in China stocks, we aim to wade through the minefield of over 200 Chinese equities, and identify the ones that these mega fund managers are most bullish and bearish about. The list includes prominent managers such as Wellington Management ($1.6 trillion in total assets under management), Vanguard Group ($1.4 trillion), Fidelity Investments ($640 billion), T Rowe Price ($330 billion), and Goldman Sachs Asset Management ($580 billion), among others.

We determined based on our analysis that mega fund managers are bullish on the Chinese companies. During the June quarter, these mega fund managers together added a net $1.39 billion to their $21.06 billion prior quarter position in the group, selling $2.44 billion and buying $3.83 million worth of stocks in the group. While Chinese solar companies were included to determine the overall tone of mega fund managers toward the China group, we excluded describing the investing activities of these mega managers in Chinese solar companies, since they were covered separately in another article that focused on the investing activities of these mega fund managers in the solar sector.

The following are the major (non-solar) China companies that these mega fund managers are most bullish about (see Table):

• Baidu Inc. (BIDU): Often touted as the Google (GOOG) of China, BIDU is a leading Chinese provider of internet search, targeted online advertising and other internet content services. Mega funds added a net $157 million to their $1.04 billion prior quarter position, and taken together mega funds hold 23.5% of the outstanding shares. The top buyer was T Rowe Price ($324 million), and the top mega fund holders are T Rowe Price ($2.53 billion) and Fidelity Investments ($1.56 billion). Overall, 517 institutions hold 70.7% of BIDU shares, with Baillie Gifford & Co ($3.61 billion) and T Rowe Price being the largest holders with 9.2% and 6.8% of the outstanding shares respectively. We recommended buying BIDU in our coverage of Chinese equities on October 3rd when it traded at $105, identifying it as the best opportunity among Chinese equities; it is now up 35% from that price in the last four weeks.
• Sina Corp. (SINA): SINA is a Chinese internet portal offering media content and services for China and global Chinese communities. Mega funds added a net $305 million to their $1.46 billion prior quarter position, and taken together mega funds hold 32.3% of the outstanding shares. The top buyers were Capital Research Global Investors ($282 million) and Goldman Sachs Asset Management ($95 million), and the top holders were T Rowe Price ($503 million) and Capital Research Global Investors ($317 million). Overall, 250 institutions hold 72.6% of SINA shares, with T Rowe Price and FIL Ltd. ($364 million) being the largest holders with 7.8% and 6.3% of the outstanding shares respectively. We recommended selling SINA in our coverage of Chinese equities on September 26th when it traded just north of $82; it closed Monday at $81.29 while the average Chinese stock is up 10% during that same period.
• Youku.com Inc. (YOKU): YOKU, China’s largest video-streaming company, is more popularly known as the YouTube of China. But in reality, it is more a combination of Netflix and YouTube; Netflix, because it offers mostly professionally-generated content licensed from movie studios and TV companies, and YouTube due to its reliance on advertising as a main source of revenue. Mega funds added a net $240 million to their $147 million prior quarter position, and taken together mega funds hold 23.6% of the outstanding shares. The top buyers were Janus Capital Management ($74 million) and T Rowe Price ($65 million). Overall, 134 institutions hold 66.4% of YOKU shares, with Brookside Capital Management ($290 million), Maverick Capital ($201 million) and Marisco Capital Management ($189 million) being the largest holders with 12.1%, 8.4% and 7.9% of the outstanding shares respectively. We turned bearish on YOKU in our coverage on August 15th when it traded at $26; it closed Monday at $21.24 while the average Chinese stock is down about 5% during that same period.
• Renren Inc. (RENN): RENN, often called the Facebook of China, is a Chinese operator of a social networking platform that enables users to communicate and share information via Renren.com. Mega funds taken together added a new $192 million position during the June quarter, and taken together mega funds hold 10.4% of the outstanding shares. The top buyers were Morgan Stanley ($65 million), Goldman Sachs Asset Management ($48 million) and Fidelity Investments ($46 million). Overall, 73 institutions hold 12.7% of YOKU shares, with General Atlantic LLC ($95 million) and Morgan Stanley being the largest holders with 1.8% and 1.2% of the outstanding shares respectively. We recommended buying RENN in our coverage of Chinese equities on October 3rd when it traded at $4.80s; it closed Monday at $7.04, up 45% from where we recommended it four weeks ago.
• Focus Media Holdings Ltd. (FMCN): FMCN operates the largest out-of-the-home digital advertising network in China through 131,006 flat-panel and 324,364 poster frame displays. Mega funds added a net $169 million to their $542 million prior quarter position, and taken together mega funds hold 17.9% of the outstanding shares. The top buyers were Fidelity Investments ($155 million) and Capital World Investors ($45 million). Overall, 200 institutions hold 56.6% of FMCN shares, with Fidelity Investments ($274 million) being the largest holder with 7.3% of the outstanding shares. We recommended buying FMCN in our coverage of big movers on October 5th when it traded in the $20 range; it closed Monday at $27.18, up over 35% from where we recommended it four weeks ago.

The following are the major (non-solar) China companies that these mega fund managers are most bearish about (see Table):

• Sohu.com Inc. (SOHU): SOHU is the third largest internet portal and a leading brand in China. It offers Chinese language web navigational and search capabilities, twelve main content channels, Web-based communications and community services, and a platform for e-commerce services. Mega funds cut a net $139 million from their $714 million prior quarter position, and taken together mega funds hold 24.5% of the outstanding shares. The top sellers were Oppenheimer Funds ($120 million) and Vanguard Group Inc. ($94 million). Overall, 213 institutions hold 65.8% of SOHU shares, with Orbis Holdings Ltd. ($468 million) and Morgan Stanley ($227 million) being the largest holders with 17.7% and 8.6% of the outstanding shares respectively. We recommended buying SOHU in our coverageof Chinese equities on October 3rd when it traded at $47, identifying it as a screaming buy, especially in relation to its peer SINA; it is now up 30% from that price in the last four weeks.
• E-commerce China Dangdang (DANG): DANG is a Chinese online retailer offering books and other media, personal care and general merchandise via Dangdang.com. Often called the Amazon (AMZN) of China, DANG is the number two e-Commerce player in China, behind TaoBao. Its business model is similar to AMZN except that it employs a courier-based delivery system that collects cash on delivery. Mega funds cut a net $26 million from their $52 million prior quarter position, and taken together mega funds hold 4.6% of the outstanding shares. The top sellers were Fidelity Investments ($16 million) and Wellington Capital Management ($8 million). Overall, 85 institutions hold 12.5% of DANG shares, with Morgan Stanley ($13 million) being the largest holders with 2.3% of the outstanding shares. We recommended buying DANG in our coverage of Chinese equities on October 3rd when it traded at $4.80s; it closed Monday at $6.97, up over 45% from where we recommended it four weeks ago.
• Chanyou.com Ltd. (CYOU): CYOU is a Chinese provider of free-to-play massively multi-player online role-playing games (MMORPGs), which are interactive online games that can be played simultaneously by various game players. Mega funds cut a net $24 million from their $83 million prior quarter position, and taken together mega funds hold 4.3% of the outstanding shares. The top sellers were Oppenheimer Funds ($9 million) and Barclays Global Investors ($6 million). Overall, 78 institutions hold 14.0% of CYOU shares, with HSBC Holdings ($38 million) being the largest holder with 6.5% of the outstanding shares.
• Harbin Electric Inc. (HRBN): HRBN is a Chinese manufacturer of electric motors, including industrial rotary, linear, and specialty motors. Mega funds cut a net $25 million from their $56 million prior quarter position, and taken together mega funds hold 4.2% of the outstanding shares. The top sellers were Vanguard Group ($17 million) and Bank of New York Mellon Corp. ($7 million). Overall, 106 institutions hold 35.4% of HRBN shares, with Pentwater Capital Management ($49 million) being the largest holder with 6.9% of the outstanding shares.

(Click chart to expand)

General Methodology and Background Information: The latest available institutional 13-F filings of over 30+ mega hedge fund and mutual fund managers were analyzed to determine their capital allocation among different industry groupings, and to determine their favorite picks and pans in each group. These mega fund managers number less than one percent of all funds and yet they control almost half of the U.S. equity discretionary fund assets. The argument is that mega institutional investors have the resources and the access to information, knowledge and expertise to conduct extensive due diligence in informing their investment decisions. When mega Institutional Investors invest and maybe even converge on a specific investment idea, the idea deserves consideration for further investigation. The savvy investor may then leverage this information either as a starting point to conduct his own due diligence.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Disclaimer: Material presented here is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion. Further, these are our ‘opinions’ and we may be wrong. We may have positions in securities mentioned in this article. You should take this into consideration before acting on any advice given in this article. If this makes you uncomfortable, then do not listen to our thoughts and opinions. The contents of this article do not take into consideration your individual investment objectives so consult with your own financial adviser before making an investment decision. Investing includes certain risks including loss of principal.

This article is tagged with: Long & Short Ideas, Fund Holdings

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