Why do short sellers think ASX lithium shares are the pick of the crop right now?

Investors are betting big that lithium shares have further to fall…

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Every week here at the Fool, we take a look at the ASX's most short-sold shares. This week's list, which my Fool colleague James covered just this morning, reveals an interesting trend: investors are betting against ASX lithium shares on masse.

Short selling involves borrowing shares from another investor with an agreed-upon return date. The shorter then sells the shares and buys them back when that return date comes around. If the company's shares have fallen in value during this time, the shorter makes a profit.

So seeing lithium shares like Pilbara Minerals Ltd (ASX: PLS), Core Lithium Ltd (ASX: CXO) and Sayona Mining Ltd (ASX: SYA) on this week's shortlist tells us that investors are putting big money into a bet that the ASX lithium sector is about to take a very cold bath.

ASX lithium leader Pilbara was actually the most short-sold share on the ASX this week, with a whopping 16% of its outstanding shares held in a short position.

However, this short-seller interest conspicuously contrasts with the enthusiasm for ASX lithium shares that we've seen from many investors over the past few years. In 2023 alone, the Pilbara share price has been up more than 50% at one point, despite the fact that on today's numbers, it's gained just 6.5% year to date.

So why have shorters suddenly turned on this once-loved corner of the market?

Why are investors short-selling ASX lithium shares right now?

Well, it's hard to know for sure. But there are a couple of factors we can point to. The first is lithium prices.

Last week, we looked at Pilbara's latest quarterly earnings update. It was quite a shocking result for Pilbara, which reported that the lithium prices it was able to command for its spodumene production came in at US$2,240 per tonne. That was a massive 31% fall from what Pilbara received in just the previous quarter.

In some commentary that came along with this update, management said the following:

Demand for lithium raw materials is expected to remain consistent in Q2 FY24 which is typically a stronger period for EV sales. Market pricing for spodumene concentrate and lithium chemicals is however likely to continue to remain volatile in the near-term given uncertain macroeconomic conditions and closely managed inventories in the supply chain.

Given this sentiment, plus the disappointing numbers Pilbara had to show, it's not too hard to see why investors might be thinking this is a good time to take some bets out against ASX lithium shares like Pilbara.

Another factor we have to consider is the current state of the stock market. The S&P/ASX 200 Index (ASX: XJO) has had a terrible time over the past few weeks, thanks in most part to concerns over the geopolitical situation in the Middle East, and its potential consequences. Since the start of August, the ASX 200 has now lost a meaningful 9% or so. That's a major sell-off.

As a growth sector that is arguably being priced on its future potential, rather than its current profitability, lithium shares are highly vulnerable to a market-wide sell-off. This is also the case with other growth sectors like tech shares. We've seen this happen before, and probably will again. As such, it's no surprise to see some investors placing bets that this will continue.

No doubt lithium investors don't exactly appreciate the love that short sellers are showing on this sector at the moment. But let's see what happens next.

Motley Fool contributor Sebastian Bowen has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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