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Why are short sellers targeting Syrah Resources Limited shares?

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Invert, always invert.” — Charlie Munger

Short sellers borrow shares in a company in order to sell them on market. Because they will have to buy back the shares in order to return them, short sellers are therefore betting that the share price will go down. Academic studies have shown that short sellers are good for the economy, and help spot fraud, but the key question for investors is whether they should avoid shorted companies, or bet against the shorts by buying shares.

Start-up graphite miner Syrah Resources Limited (ASX: SYR) had 17.7% of its shares sold short on the 22nd of May, 2017, with 46.7 million shares sold short. That’s around 25 times the daily average volume of shares traded during May, suggesting that if the short sellers get cold feet en masse, we could see a short squeeze.

One unusual thing about Syrah Resources is that it draws attention to the short selling of its own shares, in its own presentations, as you can see below.

Syrah Resources may have attracted the attention of short sellers because, “Sales and pricing mechanisms in both the flake and spherical (Battery Anode Material) markets are bespoke, bilateral and non-transparent”, according to the company. That means it’s hard to be sure what price the company will receive for its products.

I have no idea what price Syrah will receive for its products in future years. I believe there is significant uncertainty around the future price of graphite.  For example, batteries can use graphite anodes, synthetic graphite anodes, and also silicon anodes. Elon Musk is quoted as saying “over time we’ll be increasing silicon in the anode.” I would argue the price of graphite will be impacted by whether major battery manufacturers use graphite, synthetic graphite, or silicon for the anode.

While there is potential to profit from up-and-coming mining companies, I’d make the case that there are safer stocks which could still make you a pretty penny.

In the case of Syrah, the short sellers will likely profit if the company needs to raise more capital by issuing shares at a discount. However, if the company starts generating big profits, the short sellers will likely have to cover their positions all at once, causing a big spike in the share price. That might happen if Syrah’s Mozambique mine is set up on time and on budget, and the company receives a good price for its products.

I’m not sure how often new mines become operational on time and on budget. I have no real view on Syrah, but I would not choose to take on the short sellers on this one. However, I do invest in some high risk, high reward stocks, such as this medical software company.

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Claude Walker is a Motley Fool investment advisor. He does not own shares in the companies mentioned in this article. You can follow Claude on Twitter @claudedwalker. The Motley Fool's purpose is to educate, amuse and enrich investors. This article contains general investment advice only (under AFSL 400691).

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