Why red chips tumbled

SINCE December, Dao Heng's Red-chip Index has soared 40 per cent, hitting a record high of 140.88 on June 28. This compares well with the 30-per cent increase of the Hang Seng Index during the same period. However, on July 9 the Red-chip Index plunged 11 per cent to 124.89 whilst the HSI recorded only a modest loss of one per cent.

Factors precipitating the free fall in early July include: Rumours that a capital outflow back to the mainland has begun in light of China's austerity plan to try to control its overheated economy. This caused investors to adopt a wait-and-see attitude.

Rumours that the Securities and Future Commission has started investigations on the share transactions of several shell companies.

Imminent listings of China's nine state-owned enterprises on the Hongkong bourse have allured a portion of capital tied up in red chips.

The shell company euphoria appears to be waning following the plunge in share prices of shell companies over the previous two weeks, with some suffering more than a 30 per cent loss.

Shareholders of potential back-door listing targets can benefit from the substantial price increases of their companies. Buoyant speculative activity helps sustain market turnover at a high level, which in turn will boost brokerage businesses. Additionally, major shareholders of the shell companies can undertake acquisitions and inject assets via fund-raising exercises in the market.