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Hedge funds go short on Aussie banks

Australia’s hedge funds are betting against further gains in Australian banking stocks, citing the weakening dollar as the reason for foreign investment contraction.

Since the GFC, Australia has been a safe haven for international funds, with interest rates high and our credit rating impeccable. However, it seems the Australian mining boom has been the catalyst for international withdrawal.

Australia is the biggest exporter of coking coal and iron ore in the world and when prices flail, the sector struggles and so does our economy to an extent. Coupled with falling interest rates in recent months, investors turned to equities for higher yields and we’ve witnessed a very modest growth in property sales.

The appetite for high-yielding stocks drove their prices to unreasonable and unsustainable highs given the amount of growth in many of the companies. In May, we witnessed a “banking bubble” that has, according to many investors, been popped when the stock prices of our biggest banks like Westpac (ASX: WBC) and NAB (ASX: NAB) dropped well over 10%.

However, banks most heavily exposed to large mortgage books are likely to be shorted more than others. The Commonwealth Bank (ASX: CBA) and Westpac are the country’s two biggest holders of this finance and the number of short positions on them have risen by 48% and 106% respectively, according to ASIC.

‘Shorting’ is essentially borrowing the stock from a shareholder or lender for a particular fee and selling it at its current price. Then the short seller waits for it to drop before repurchasing or ‘covering’ the same stock and returning the shares to the lender, who must accept the shares. Although the amount of shares being shorted in bank stocks has risen, it’s still nowhere near what it was during the GFC.

Many believe that the act of short selling greatly exacerbated the blowout of the GFC. Investors could buy a stock in say Lehman Brothers, knowing that it was going to take a huge hit and then sell it back to the lender for a massive profit. This put huge downward pressure on the stock prices and was the reason why a number of countries banned short selling, although it had little effect.

Foolish takeaway

The banks are not the most shorted stocks on the market but short sellers rarely get it wrong. However, Australian banks are not the same as their foreign counterparts and as long as investors buy at the right price, the potential for a loss is mitigated. This is especially important because they are not as likely to grow at the same rate in the next five years as they have in the preceding half decade due to tighter economic conditions.

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Motley Fool contributor Owen Raszkiewicz owns shares in ANZ. 

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