Doug Goodwille from Kayne Anderson speaks to Drew Meredith from The Inside Network on market thinkers.
While a surging gold price is on hold as the world adjusts to a Trump presidency, all the factors that saw its price rise more than 50 per during his first term in office – trade disputes, fiscal deficits and geopolitical tensions – are almost certainly guaranteed the second time around.
What is a short squeeze?
First, it was GameStop and the era of the ‘meme’ stocks. Then it was the Archegos hedge fund making massive bets on well-known technology companies. More recently, it was a massive spike in the price of Nickel. What all these events have in common was that they all involved a ‘short squeeze’.
Short squeezes have attracted more headlines than ever in the last 12 months as most resulted in significant jumps in volatility in both equity markets and the share prices of individual companies. To understand the concept of a short squeeze, you must first understand the process and purpose of shorting.
For those not aware, professional investments like hedge funds, managed funds and ETFs are able to make two types of investments into the shares of a company. They can go ‘long’ or ‘short’. Long refers to the process of buying and holding a listed share like BHP, whilst shorting is a little more complex.
Shorting is the process of borrowing someone else’s shares in BHP, say an index fund or an industry super fund, and selling those shares on the ASX. At an agreed point in time, the lender will want those shares returned, forcing the borrower to buy them back on market. Ultimately, the aim of shorting is to identify companies that are expected to fall in value, sell their stock short, and repurchase it at a lower price, making a neat profit in the process.
There is a significantly different risk profile in going short versus long. In the case of long positions, your losses are capped at 100 per cent of your capital, as a share cannot have a negative share price. For shorting, however, the potential losses are infinite, as there is no cap on share prices. Consider those who shorted Tesla at $50 per share for example.
Shorting isn’t always about profiting from a fall in the share price, in fact there are many other reasons that companies or fund managers may use this process. For instance, a fund manager with a large holding in BHP may wish to reduce their exposure ahead of an event, but prefer not to realise a capital gain by selling their holding. They could take out a short position to do this.
Similarly, commodity companies are often required to lock in prices on their production, which exposes them to the risk that the price moves in the opposite direction. This was certainly the case for the Nickel market in 2022.
A short squeeze occurs when for one reason or another, those people holding short positions in a stock all race to the exit and are forced to buy back shares in the company at the same time. Naturally, this results in a significant jump in the share price. Some of the more common reasons that this occurs is unexpected news about the companies profitability, takeover offers, changes of management and even buybacks.
