Hedge fund short sellers were left with egg on their faces after shares in aluminium producer China Zhongwang Holdings, one of the most heavily bet-against stocks on the market, rallied 15.3 per cent yesterday to HK$8.07, completing a 39 per cent rise in eight days. Zhongwang had been accused last year by the mainland media of falsifying its April initial public offering prospectus. Its shares achieved the stellar turnaround after the company announced on Tuesday night that independent auditor Ernst & Young said there were 'no discrepancies' in the prospectus. Neither the company nor Ernst & Young released the report. In mid-September, the China Economic Observer said in a report, which it later retracted, that the top 10 customers named in Zhongwang's listing prospectus did not buy from the company in 2008. Ernst & Young's ruling not only influenced fund managers to buy the stock. It also forced short sellers to buy in a scramble to cover their speculative positions. Hedge funds have been targeting Zhongwang, which raised HK$9.8 billion in its offering, since July last year. Many decided the aluminium extruder's story raised more questions than it answered. Those who made the bet in July or early August, when Zhongwang traded at about HK$10, profited handsomely. However, most hedge funds attacked the company in early November, when the stock fell below HK$6. At that point, brokers had lent out 20 per cent of the aluminium producers' shares to short sellers, according to Bloomberg. Short sellers sell borrowed stock which they hope to buy back at a cheaper price. An analyst who covers Zhongwang - who requested anonymity because he is not authorised to speak to the media - said the sharp rally in the aluminium extruder's shares since December 30, when they traded at just HK$5.80, was a 'short squeeze'. Short sellers set a price with brokers at which they will buy the borrowed stocks if they rise, to insure themselves against unlimited losses. If the company's shares then climb, the funds pile into the stock to cement their speculative positions. In other words, they are 'squeezed' into buying the stock. Zhongwang's shares began rising on December 31 because the company told the stock market that the Ernst &Young report was almost ready. 'They would not have said that unless the report was going to be good,' said the analyst. Privately, Zhongwang's management has been complaining for months about the hedge fund attack, which came about because short sellers perceived discrepancies in the company's information. Speaking on condition of anonymity, one short seller said he was confused by Zhongwang's export sales. In its April listing prospectus, the firm said that less than 3 per cent of its sales came from outside the mainland in 2008. By September, 25 per cent of the sales came from overseas. 'I am still scratching my head over how Zhongwang changed the complexion of its business so quickly,' the short seller said. Zhongwang finance director Vincent Cheung Lap-kei declined to comment. Other hedge funds bet against Zhongwang after investment analysts tried to clarify its sales data with its customers but came up with inconclusive results. In a note published on October 27, Cazenove analyst Ole Hui wrote that he was told by a customer named in the aluminium producer's prospectus, Xi'an Feibao Airport Equipment, that it mainly used steel. Another customer, Lingyun Industrial Corp, told Cazenove that while it bought from Zhongwang, its use of extruded aluminium was 'very small'. Hui said yesterday these interviews might have sent investors the wrong message. 'As we never had the same level of access afforded to the auditors [Ernst & Young], our analysis could not reveal black and white answers,' he said in a research note. Hui has now put a HK$10.70 target price on Zhongwang's shares. In two interviews with the South China Morning Post, on September 16 and October 27, the board secretary of another company named by Zhongwang as a top 10 customer, manufacturer Baotou Beifang Chuangye, said his firm did not buy from Zhongwang. The Baotou board secretary, Cheng Tiangang, then clarified in a November interview that his company bought products from Zhongwang to make 'national security sensitive products for the military'. The firm did not disclose that it did any business with military suppliers in its share offering prospectus. Another question hanging over Zhongwang is why the company chose not to make the Ernst & Young report into its share-sale document public. In a November 10 conference call with investors, Cheung gave the impression his company would release the full report to the market. 'We appointed [Ernst & Young] to give [the] result to [the] media, investors and [the] market,' he said. Yesterday, he declined to comment. The Zhongwang case echoes a similar trading debacle in October 2008 when hedge funds were caught out after making a wrong-way negative bet on the fortunes of Volkswagen. The carmaker's shares surged 93 per cent in a day after Porsche announced it had bought majority control of Volkswagen. Market commentators said the rally was the result of short sellers covering their positions.