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August 27, 2007

Aluminum Corp. of China Limited (ADR) is Worth $156?

posted by MR WAVETHEORY at 8/27/2007 11:32:00 PM
I was looking at the top gainers list and at the top today was Aluminum Corp. of China Limited (ADR) also known as Chalco (NYSE ACH). It was +24 points today and closed at $67.46. Chalco also happens to be one of the top gainers this year. It was only trading at $15 a year ago. I dug around to see what is going on and it appears that this is the perfect arbitrage stock. You see, Chalco also trades in Hong Kong and Shanghai.

Chart of ACH - Chalco ADR

The stock is moving up in Hong Kong. The ADR on the NYSE which is ACH is the equivalent of 25 Hong Kong Shares of Chalco which trades under the symbol 2600.HK. When I checked the price of Chalco in HK yesterday, it was trading at 20 HKD per share. Using that figure, each share of ACH was worth

Chart of Chalco H-Share - Hong Kong

20 HKD X 25 shares of HK Shares = 500 HKD per share of ACH

How much is it worth in dollars? To make the calculation easier, I will assume that 1 HKD is worth 8 USD.

500 HKD / 8 = $62.50

But wait! Why are the Hong Kong shares of Chalco 2600.HK moving up? It's because the Chinese government has announced a program to allow mainland Chinese investors to buy Hong Kong shares. In Shanghai, Chalco trades at an even higher price than 20 HKD per share. In fact, in Shanghai, Chalco traded at 50 yuan yesterday which is more than twice the price of the H-share. The symbol in Shanghai is 601600.ss and the name of the company is 中国铝业. These are called A-Shares.

Chart of Chalco - A-Share Shanghai

Wouldn't it be cool if we could figure the value of the ADR if the ADR converged to the A-share price? In finance, this is known as an arbitrage free condition. Let's assume that each ADR is convertible into 25 A-Shares (which it is not by the way). But for the sake of an experiment, let's say it is. Then,

50 Yuan Per A-share X 25 shares of A-Shares per ADR = 1250 Yuan.

Now, let's convert that into US dollars at an 8 to 1 exchange rate - this is a very very rough estimate by the way.

1250 Yuan / 8 Yuan Per USD = $156.25 per ADR

So, assuming that each ADR is convertiable into 25 A-shares, each ADR of Chalco (ticker symbol ACH) would be worth $156 per share. The current price of Chalco is $67 per share. That implies 138% upside assume perfectly efficient markets and arbitrate free conditions.

It's nice to be able to do the math because we may have uncovered the reason behind the wild move! This partially explains why Chalco moved up 24 points today.

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