Behind the $2b bet against the ASX’s favourite lithium stockIt’s retail investors and the nation’s largest super funds versus the hedge funds in a multibillion-dollar wager on the future of the coveted metal.Jonathan ShapiroDec 3, 2023 – 12.12pm, first published at 10.26am
Opinion
Senior reporter
Pilbara Minerals’ lithium project in Western Australia. Christian Sprogoenone
The lithium miner is the most actively traded ASX stock on CommSec. And it is the most shorted stock on the market, with more than 20 per cent of its outstanding shares loaned to speculators who are betting on a fall.
But the speed and scale of shorting activity around Pilbara Minerals in just a matter of weeks is astounding.
Hedge funds have now amassed a $2.3 billion position against it. In just six weeks, a further $980 million has been wagered on a price drop without any obvious catalyst to increase the shorts’ conviction.
It’s not the first time an ASX-listed stock has had one-fifth of the register sold short. But typically, the No. 1-shorted stock has about 10 to 15 per cent of its outstanding shares loaned out to speculators.
This column spoke to traders and fund managers in an attempt to understand what is driving the extreme sentiment. Their responses suggested there was a mix of technical trading-related factors, and divergent views on the fundamental assumption that the lithium market is challenged for a while yet.
One factor driving more short bets – although traders are split on its influence – is the ban on short selling imposed in the
South Korean equity market last month. That market is home to battery manufacturers, which rallied hard when the ban was announced.
This, some believe, has forced lithium bears to shift more of their capital onto the ASX and to Pilbara Minerals, which provides the purest exposure to the lithium spot price, relative to other potential local targets.
“Lithium prices are … starting to breach the top end of the current cost curve of the industry, a marker in any commodity’s cycle,” says AusSuper’s Luke Smith. Yianni Aspradakisnone
Pilbara Minerals is large and liquid, with a mix of retail investors and institutions trading the stock, and the latter making their shares available to borrow.
Morgan Stanley data pinned Pilbara Minerals as the most actively traded large-cap stock among retail investors, who accounted for about 12 per cent of turnover.
Another possible factor driving the surge in short interest is quantitative hedge funds. An earnings downgrade and falling share price are negative momentum signals that suck in programmatic traders which hunt for trends to follow.
Typically, hedge funds avoid crowded short trades. Even a whiff of good news can create a short squeeze as long-short strategies scramble to buy back stock, triggering a further run up in price. While this excites the bulls, some shorts don’t seem too worried.
So long as the lithium price remains low, and earnings are declining, the prospect of a squeeze is adequately small to them.
Those are the market-related factors behind the short herding. The deeper, longer-term motivation of short sellers to either hold or add to their position is the unwavering belief that the worst is not over for the lithium sector.
Hedge funds have been shorting lithium stocks for months on the premise that demand for electric vehicles will taper off as it becomes harder to achieve cost parity with internal combustion engines.
But the supply of lithium has now slowed, particularly in China, which produces the commodity at a low cost.
Battery bearsThe bear case has largely played out. The price of lithium rich spodumene concentrate dug and shipped from Western Australia has fallen from $US8000 a tonne in January to $US1675 ($2512) a tonne this week.
The collapse in lithium prices is due in part to a drop-off in demand as the growth in sales of electric vehicles has been lower than expected, while new battery manufacturing facilities are working through inventories.
Eventually, lithium bulls and producers believe
the demand for lithium batteries to power electric vehicles will simply create the demand required to absorb supply.
The short thesis is that demand will matter less than supply, as low-cost producers such as Pilbara Minerals can still make good margins at these prices, which could slide back to 2021 levels.
The strength in iron ore – which has equally surprised investors – is a good demonstration of how supply matters more than demand in the medium term.
The price of iron ore has held up well despite subdued demand because of constrained supply. For lithium, a looming supply glut may keep prices low, even if demand is strong.
A further point in the bear thesis is the rise of competing technologies to lithium-ion batteries
such as sodium-ion or the solid-state battery technology
being developed by Toyota.The potential to disrupt lithium isn’t worrying lithium executives, but it is being talked about in the market and at the very least creating some apprehension.
Marginal costThe lithium bulls are battered and bruised. But those that still believe in the thematic are holding firm. And at least some traders that shorted lithium stocks have covered their positions and are eyeing a possible long in the likes of Pilbara Minerals.
Their reasoning is the fall in lithium prices has meant that it is approaching its marginal cost of production, and therefore something near a long-run price.
That is the reason cited by AustralianSuper’s Luke Smith when asked about the pension fund acquiring its substantial position in Pilbara Minerals.
“Lithium prices are currently deflated and are now starting to breach the top end of the current cost curve of the industry, a marker in any commodity’s cycle,” he said.
“Overlaying this is the lithium and downstream electric vehicle market where supply and demand are both growing strongly at well over 15 per cent annually, and the sector is forecast to remain strong for a number of years.”
Has the big pension giant’s conviction investment forced shorts to reconsider?
Ironically, not. The more institutional investors there are on the register, the more stable the pool of shares available to borrow.
AustralianSuper has also shown with Origin that it will resist takeovers if they’re well below its assessment of fair value.
Therefore, the pension fund’s holding lowers the biggest risk facing short-sellers: the prospect of a bid at a substantial premium to the last traded price that would trigger a short squeeze.
The bulls, which includes some fast money too, say the current price is compelling relative to long-run valuation assumptions, and are eyeing their entry point.
So, all sides in this epic battle are standing their ground, betting their bonuses, their members’ capital and hard-earned savings on where the lithium price will settle. Start your engines.
(20min delay)