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ASX caught in billion-dollar short squeeze as hedge funds shuffle bets

Joshua PeachMarkets reporter

Mar 7, 2024 – 1.52pm

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Hedge funds exited just shy of $1 billion in short positions in the final days of February as speculators closed out bets against beaten-up lithium and nickel stocks.

Instead, they shifted their short positions to some of the largest names on the ASX, including Commonwealth Bank and iron ore majors Rio Tinto and BHP Group.

Hedge funds covered some $970 million in shorted shares in the final week of February. Christopher Pearce

ASIC data analysed by The Australian Financial Review shows some $967 million worth of shorted shares were covered in the final week of February, based on recent share prices. Fund managers have said the pick-up in shorting activity had led to one of the most volatile earnings seasons on record.

Short sellers, which look to profit from a falling share price, are required to buy shares to cover their position and close the short. This can lead to what is known as a “short squeeze”, when the surge in buying activity can result in an outsized spike in the share price.

“In February 2024, the most shorted securities outperformed the least shorted by 8.8 per cent,” said State Street Global Advisors’ head of Australian portfolio management, Bruce Apted, in a note to clients, referring to the most recent earnings season.

“This also lines up with a reversal of some of the ‘negative’ momentum trades being unwound.”

The huge rotation in positioning has pulled down the short interest in some of the ASX’s most heavily shorted stocks, including some lithium and nickel miners, which have ranked among the most shorted for months.

The rotation out of nickel and lithium producer IGO is among the most pronounced. More than 25 million shares in the beaten-up stock were covered by short sellers in the final days of February, amounting to more than $200 million based on the current share price.

The stock had plunged more than 40 per cent in the past 12 months, pulled down by a sustained rout in the price of nickel and lithium.

The metals collapse drove short positions in IGO to as high as 4.3 per cent of the share float by February 26. Days later, that figure plunged to just 0.85 per cent, coinciding with an 8 per cent jump in the share price the same week.

Core Lithium also recorded a steep drop in short interest from around 13 per cent in mid-February – which at the time made it the third most shorted stock on the index – to now stand at around 8.8 per cent. Short sellers also piled out of coal producer Yancoal and financial group Macquarie, covering around $100 million worth of shares in the final days of February.

Earlier this week, analysts at Goldman Sachs warned traders against misconstruing the recent rally in nickel and lithium price, attributing the rise to commodity traders also covering their short positions.

Lithium developer Sayona Mining and nickel explorer Chalice Mining both recorded steep declines in short interest last month, which coincided with strong share price performances.

Despite the shake-up, hedge funds are continuing to bet heavily against Pilbara Minerals, the bourse’s long-standing most-shorted stock. At 21 per cent of the share float, shorts on the iron ore and lithium producer now amount to more than $2.5 billion based on current share prices.

Commenting on the bourse’s recent volatility, Martin Conlon, head of Australian equities at Schroders said it was always difficult to discern the extent to which passive money, short covering, quantitative buying or selling was impacting the market at a given time.

“Short covering can induce high volatility only when buying is price insensitive. Logic would suggest short covering should be price sensitive given its cost to returns, however, any rules-based trading – when limits are set and followed regardless of price – can induce large price moves,” he added.

Hedge funds caught short

Short sellers also ditched some of last month’s best-performing stocks, including discount jewellery retailer Lovisa and logistics tech developer WiseTech. Both stocks have rallied more than 20 per cent so far this year.

Long-short fund manager at Totus Capital Ben McGarry said it was a difficult environment for short selling in February.

“Equity markets continue to melt up driven by excitement about [artificial intelligence], a more dovish Federal Reserve and expectations of a soft landing or no landing for the global economy,” he said.

“The consumer slowdown we had expected in 2023 hasn’t yet materialised and at full-employment, banks and housing exposed stocks have been resilient.”

As hedge funds retreated from the ASX’s most heavily shorted stocks, they simultaneously piled into some of Australia’s biggest public companies.

CBA, the ASX’s largest stock by market capitalisation, drew more than $300 million in fresh short bets in the final days of February.

Before the surge, short interest in the big four banks had been trending lower since mid-December, with Barrenjoey bank analyst Jon Mott noting in a February report that short covering was one factor behind CBA’s strong rally in 2024.

Rio Tinto has become another target, with bets against the stock now amounting to around 3 per cent of the miner’s float, its highest point in more than three years. Similar jumps were recorded for bets against CSL, BHP and Wesfarmers.

However, it was Seven Group that has drawn the starkest increase in short bets. The Kerry Stokes-owned company has recorded a 1.5 per cent jump in short interest since its full-year results were released in mid-February alongside news of a bid for the remaining stake in fellow ASX-lister Boral.

The short bets against Seven Group now amount to more than $250 million.