Few countries trade with so much volatility in investor sentiment as China. Investors are manic about watching economic reports from the world’s second largest economy, and the slightest change in statistics can mean a plunge in sentiment. 

Shares trading on the Shanghai Stock Exchange are up 74% over the last ten years, but the long-term note masks some spectacular ups and downs over shorter periods. The index lost 28% of its value over the last nine months of 2011. And who can forget the meteoric boom over the year to June 2015 when the market surged 140%?

#-ad_banner-#Investors have once again abandoned shares of Chinese companies despite strong economic fundamentals and valuation. I’ve already put together two trades on the theme for a gain of 54% and 45% in less than three months’ time.

Now I’m going for the long-term trade on China for even stronger gains as fundamentals come back to drive shares higher. 

Recent Economic Reports Have Investors Fleeing
The release of three economic reports late May renewed fears of a hard landing for the Chinese economy. The official May manufacturing PMI was unchanged from April at 50.1 to mark the third month just barely above the 50-level for expansion. 

A separate survey measuring small- and medium-sized companies fell for the 15th consecutive month to 49.2 last month, signaling contraction. The government also reported the service sector dropped to 53.1 in May, threatening the idea that service sector growth could support the transition from an export-led economy. 

Beyond the prospect of a struggling economy, Chinese companies listed as American Depositary Receipts (ADRs) in the United States have also been under pressure since May 6 when the China Securities Regulatory Commission announced it was studying the impact of companies delisting on foreign exchanges through a private buyout to relist on domestic exchanges. More than 40 Chinese companies with ADR shares have received buyout offers since early 2015 for more than $35 billion, with about three-quarters of the deals yet to complete.

The idea is that the companies can delist overseas to issue shares in the growing Chinese market, fetching a huge premium if they go public during one of the market’s frenzied surges. 

China bears like to point to questionable statistics and the undeniable fact that the country isn’t growing by double digits as it did in the past. Even on a slowing economy, the IMF expects China’s GDP to grow by 6.5% this year and 6.2% in 2017. That’s more than three-times the growth expected in advanced economies. High income growth and structural reforms are expected to further the transition from manufacturing to a service- and consumption-driven economy.

One statistic being sorely overlooked by the bears is the staggering amount of foreign investment being made by China and its citizens every year. Investment abroad through outbound foreign direct investment already tops $1.2 trillion and is expected to reach $2 trillion by 2020, making China one of the largest cross-border investors in the world. This number doesn’t include the massive amount of foreign exchange reserves and portfolio investments held by the world’s second largest economy, bringing total Chinese-owned offshore assets to $6.4 trillion and which are estimated to grow to $20 trillion by 2020. On the current weakness in advanced economies, China represents 25% of total global investment. That pace of investment now is going to fuel consumption and the domestic economy in the future.

Flip-Flopping On China For Big Returns
I haven’t been a perma-bull on China, positioning against the iShares China Large Cap (NYSE: FXI) in May of last year with a put options strategy that resulted in a 54% gain in less than two months.

I was back in on the China trade in September, this time buying call options on the potential for government stimulus to support the struggling economy. I positioned in the December call options at the $36 strike price for a $2.75 premium. My $40 target price was reached late October and the options were sold for a 45% profit in just over a month’s time.

Long-term investors don’t have to worry about getting in and out at the right time. The recent hit to investor sentiment has made shares of Chinese companies attractive again. The SPDR S&P China ETF (NYSE: GXC) is down 6% this year and it’s more than 30% off its high from April of last year. Shares trade for just 10.5 times forward earnings of the 359 companies held, a discount of 40% to the forward multiple of 17.8 times on stocks in the S&P 500. The fund has made several runs to $75 and beyond over the last few years, including last year’s rally that went to nearly $100 per share. I would be a buyer to $72.50 with a short-term target of $80 per share which is 14% above the current trade. Over the long-term, shares will eventually take out their previous high as the economy grows and Chinese corporations expand their influence outside the country.

Irrespective of the ups and downs in the market, which make for great short-term trades on the herd mentality, the long-term picture makes for a strong investment as China takes its place on the global stage. Economic growth is still the envy of everyone but a few countries, and China is quickly becoming the owner-of-record to the world’s assets.

Understand that not all China ETFs are created equal, the larger iShares FXI is heavily weighted to financials (52% of holdings) against the relative diversification in the GXC which holds only 30% in financials, followed by IT (28%) and consumer discretionary (10%). The large weighting to financials may cause the FXI to lag if the government further weakens the Yuan, causing more capital flight and draining domestic banks.

Risks To Consider: Chinese stocks may remain undervalued for an extended time before surging as investors return to the space.

Action To Take: Take the contrarian side to go long on shares of the China ETF as investors flee on a temporary slowdown. Near-term upside on improved sentiment and stronger long-term gains await as China becomes a real economic powerhouse.

Editor’s Note: It’s been called “shockingly accurate.” That’s because this powerful buy/sell indicator has quietly been crushing the S&P, delivering gains of 72%… 89%… even 128% all in less than a year. You can find out which stocks it’s signaling as a “buy” right now by clicking here.