Over the past month on the Toronto Stock Exchange, there were significant increases in short sales of exchange-traded funds (ETFs) tracking bond markets, a development which may presage an upturn in the economy, inflation and interest rates. There were also large increases for banking and precious-metals stocks, according to data-analytics firm S3 Partners.
There were sizable declines in short interest for the long suffering cannabis and energy sectors as well, providing a glimmer of hope that the worse may finally be over for these stocks.
Lastly, the cost to borrow selected stocks is examined, ending with a brief description of a little-known method for augmenting returns via interest rates of up to 100 per cent on stocks loaned out to short sellers.
Of the ten largest increases in short sales of ETFs during the first half of September, nearly all were registered by bond and income ETFs. Perhaps this development – especially if it extends into upcoming weeks –is foreshadowing a pickup in world economies and inflation. That’s the kind of environment that would cause the prices of bonds and income securities to decline and generate profits for short sellers.
It wouldn’t be an overly surprising development: the stimulus unleashed by policymakers in response to COVID-19 has been massive and is now triggering a sharp upturn in the purchases of houses – which historically leads an upswing in the broader economy. Investment firm Arbor Research & Trading provides collaborating evidence: inflows into the ETF tracking Treasury Inflation-Protected Securities (TIPS) in the United States reached record levels over the past three months.
Banks and precious-metals miners dominate the list of companies with the largest increases in short interest over the past three months. If a ramp-up in business conditions and inflation is in the cards, it could result in an end to the historically low interest rates that have triggered a wave of buying in property and precious-metals markets.
GFL Environmental Inc. stormed onto the table with a 112-per-cent hike in short interest, the highest of the group. The waste-management firm was targeted in August by activist short-selling firm Spruce Point Capital Management, which accused it of using aggressive accounting to inflate its balance sheet. It was also alleged that company executives had highly questionable business connections.
Two beaten up sectors of the stock market, cannabis and energy producers, are seeing some of the largest declines in short interest. Perhaps this may signal an end to the carnage suffered since 2019? The cannabis firms include: Canopy Growth Corp., Aurora Cannabis Inc. Tilray Inc. and Cronos Group Inc.; the energy firms include: Canadian National Resources Ltd., Suncor Energy Inc., Imperial Oil Ltd., Pembina Pipeline Corp., Brookfield Renewable Partners LP, Ovintiv Inc. and Enbridge Inc.
Rocketing to the top of firms with the highest percentage of float short is Just Energy Group Inc., a marketer of electricity and natural gas contracts. It does a lot of selling through door-to-door channels and kiosks at malls, which is not an easy business model to ply in the midst of a pandemic.
The company is carrying out a re-organization whereby its preferred shares and debt will convert into common shares. As initially set up, the conversion would occur at a lower price than the common shares trading in the market. So there was an opportunity to arbitrage the price differential by shorting the common shares and going long on the preferreds and bonds.
The most expensive stocks to short (as of Sept. 24)
The cost to borrow UrtheCast Corp. shares has soared to 356 per cent, making it the most expensive stock to sell short as of Sept. 24. Shortly after raising $1 million in financing, the microcap company filed for creditor protection, which means its shares will likely be delisted.
Also leaping onto the list of most expensive shares was Calfrac Well Services Ltd.. The provider of technical services to oil-and-gas wells has been hit hard by the industry’s suspension of capex while oil and gas prices remain depressed. As a result, it is planning to recapitalize by converting $570 million of long-term debt into equity, vastly diluting existing shareholders.
How to profit from short sellers
Fees to borrow stocks can be high, even above 100 per cent. If an investor owns stocks with high borrow fees, they should hold them at a broker that shares the fees. To illustrate the advantage, consider a portfolio of five companies selected at random from a sample of expensive-to-borrow shares.
An average of $5000 is invested (on paper) into each stock in early January of 2017 and held to mid-September of 2020. Back data and preliminary calculations show that the average annual return at Broker A (no sharing of borrow fees) is negative 1.6 per cent; at Broker B (shares half of borrow fees), it is 21.6 per cent.
Keep in mind that this finding is only illustrative: portfolios of different sizes and composition will yield different results. Hard-to-borrow stocks also tend to be speculative in nature, suitable mainly for investors with high risk tolerances.
Larry MacDonald is an author, journalist and economist. He can be reached at email@example.com
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