Short sellers target lithium stocks as the sector appears overheated

Short sellers are targeting lithium miners and explorers in the latest sign that the key battery metal is running out of steam after two years of spectacular price increases.

Warning bells about the outlook for lithium have been ringing since the middle of last year when leading investment bank, Goldman Sachs, told clients that the price of lithium had run too far, too fast and a fall was inevitable.

In hindsight, that warning in June from Goldman Sachs was premature because the price of lithium carbonate (the most commonly traded form of a commodity with a notoriously opaque market) continued to rise for the next five months.

But towards the end of last year, the lithium carbonate price started to roll over.

Short selling data

Some investors are seeing the same signs of an overheated market and their share trading is being reflected in the latest short-selling data.

Three of the top 10 shorted stocks on the ASX are exposed to lithium, they are:

• Sayona Mining (ASX: SYA) is fourth on the list with 10.12% of its issued capital reported as being short sold;
• Core Lithium (ASX: CXO) is fifth with 8.02% of its capital sold short;
• Lake Resources (ASX: LKE) is seventh with 7.53% of its capital sold short; and
• Vulcan Energy (ASX: VUL) is another company specialising in lithium and makes the top 20 shorted stocks at 14^th, with 6.71% of its capital short sold.

Good or bad investment decision?

Whether the short sellers have made a good (or bad) investment decision is impossible to know because it depends on when the booked their transactions.

Sayona, for example, is up 30% on its share price of six months ago ($0.15 to $0.21) thanks to interest in its North American lithium operations which are heading towards a re-start in the current quarter. But, since hitting $0.36 in September last year, the stock has shed 40%.

It’s a similar story with Core, Lake, and Vulcan, which are all trading higher than they were six months ago but are well down on their prices of three months ago – a trend which reflects the underlying concern about the outlook for the price of lithium.

Price setter

Pilbara Minerals (ASX: PLS) is 68th on the shorted stock list with 3.39% of its capital sold short. The company has been a price-setter for the industry through its well-publicised sales of spodumene (part-processed lithium ore) and has seen its share price perform in an identical way as investors react to investment bank warnings.

Over the past six months Pilbara has been a stock market star thanks largely to the receipt of spectacular prices for small cargoes of spodumene sold on the specialist BMX website

In the five months to early November, Pilbara shares rocketed by 150% from $2.26 to an all-time high of $5.66 – powered by the excitement of spodumene auctioned at prices up to US$8,575 a tonne.

But since that peak price was reported on 16 October, spodumene has been easing with the latest BMX auction on 14 December resulting in a price of US$8,299/t.

Lithium’s direction

The challenge for investors is knowing the future direction of lithium, which is a captive of the electric vehicle market, particularly at this stage of the EV revolution to Chinese demand which is, in turn, heavily influenced by tax incentives for car buyers to switch to electric and uncertainty about China’s latest Covid crisis.

Over time, lithium and the rest of the battery metals family will enjoy a bright future but getting there is proving to be a rocky road.

Just as Goldman Sachs was premature with its lithium price warning, it is equally possible that the latest outbreak of negative sentiment is overly bearish with the optimism/pessimism pendulum likely to make a positive swing later in the year as EV sales pick up after central banks finish their interest rate hiking cycle and China fully re-opens.

Market bull

Macquarie Bank is the biggest bull among the investment banks with buy recommendations on all the lithium stocks it researches led by a price forecast for Liontown (ASX: LTR) of $3.40, 172% higher than the stock’s last sales at $1.25.

Pilbara is another stock expected by Macquarie to outperform with its price tipped to double from last sales at $3.70 to $7.50.

The short sellers active in lithium stocks obviously do not share Macquarie’s optimism and could be reacting to the latest warnings from two other banks, Morgan Stanley and JP Morgan.

Three weeks ago, Morgan Stanley told clients that it was “seeing some weakness in lithium prices” in a report headline “Lithium prices turning?”

That comment was sparked by the 3% decline in Pilbara’s mid-December BMX auction result compared with the November result.

But Morgan Stanley added that the BMX auction correction was “not necessarily the beginning of the price inflection we are expecting in 2023” as decelerating demand growth eases market tightness.

JP Morgan also expects lithium prices to remain elevated, perhaps for several years, as supply struggles to keep up with demand, boosted by difficulties in developing new mines thanks to approval and construction delays.

The real problem for lithium, which is a commonly occurring commodity in most countries, is that over time a significant glut of material could develop, especially if most of the 100 proposed projects get off the ground.

JP Morgan questioned whether lithium supply could rise quickly in a project development stampede, questioning whether the lithium industry would suffer “death by a thousand cuts” as new projects came online or whether “the mining industry would fail to deliver, as it usually does”.

Long-term outlook

Long-term, JP Morgan expects the price of lithium carbonate (and hydroxide) to retreat to around US$18,000/t (down 75% on recent sales in China at US$75,000/t) and for spodumene to trade at US$1,250/t, 85% below that last Pilbara BMX auction price and 80% below its US$6,300/t contract price with major customers reported last month.

It is entirely possible that just as Goldman Sachs moved too early with its lithium price warning last June short sellers have moved too soon with the negative trades in lithium explorers and miners.

But from a long-term perspective it seems more likely than not that lithium is at peak with rising supply of an easy-to-mine material likely to flood the market with lowest-cost producers emerging as winners in a classic commodity cycle.