Like all of us short sellers win and short sellers lose. Knowing when they will lose can be a very powerful timing tool to enter stocks that could experience a significant short covering squeeze, leading to amplified rallies in share prices as they all rush for the exits.
We specifically highlighted one stock in my column on the 6th May that was ripe for a short squeeze – JB Hi-Fi (JBH). The combination of a once in a decade trading pattern, combined with the demise of Dick Smith leading to greater trading volumes for JBH, seasonal cycles AND a significantly large short position were the perfect ingredients for the share price to reach our target of $30 from levels around $24.
The chart below shows the multi-year resistance that stretched back to the 2010 highs – a resistance level that capped the stock for 6 years. A likely break above that would lead to a substantial re-rating. These patterns when combined with an underlying bullish fundamental trend is extremely powerful, with the added bonus if the stock is excessively short sold as JBH was.
We would now take profits and look to rotate into other excessively short sold stocks. This is where the oil sector and oil services sector attracts. I wrote about the merits of oil and energy producers in my 27th May column, suggesting that it appeared to be in a similar position to the gold sector two years ago when gold companies restructure themselves to be able to handle lower gold prices. This left them extremely leveraged to the prospect of higher prices and as soon as the gold price stabilized, they rocketed higher. Oil companies are doing the same now and once oil stabilizes (which I believe it has done and poised for a serious rally), all energy producers will benefit along with energy services companies. Importantly this space is not only a seriously underweight position for many fund managers but many hedge funds are still short.
First let’s look at oil on a weekly chart. After a serious decline in 2015, prices have stabilized and now have formed a textbook inverted head and shoulders pattern. For non-technically minded readers this is a significant pattern as not only is it a rarer formation than many other ‘bottoming patterns’ but to have one that is so clear cut is rarer still and shows real symmetrical behavior in the oil market. Moreover, the fact that has formed across weekly timeframes and taken almost 12-months duration underpins its significance and importance.
A move now in oil through $50/51 should trigger a sharp extension to $60. All the bad news is currently priced into oil. We know that Iran is producing at a rate of knots and that OPEC to date has not been able to agree on production cutbacks. The green energy movement has also taken away the luster of oil as well. However, anything from a weaker US dollar, to lower adoption rates of electric cars than forecasted (my personal view), OPEC agreeing on cutbacks or even a synchronized rebound in global growth could spark a sharp and swift rally.
As a result we have continued to see improvement in the oil producers and oil services companies. The US-listed Energy Producers ETF (XLE) has just broken out overnight from a very large and significant base. This base pattern has been mirrored across dozens of globally listed energy related stocks over the past 12 months. This shows that many of the stocks are trading as a reflection of the oil industry as a “whole” and not on an individual basis. Therefore, if oil can continue to rise than the global oil sector could explode to the upside fueled by genuine long-only buying and fueled by short sellers panicking to cover.
We previously highlighted Origin Energy (ORG) as one that appealed and it is yet to take off. In fact prior to last night almost all the oil stocks have failed to do so. But investors can choose between Oil Search, Santos, Beach Petroleum and Woodside Petroleum (in that order) to gain exposure.
One other stock that is ripe for a massive short-covering rally (and broke out yesterday from an identical pattern to the XLE ETF is Worley Parsons (WOR). WOR is one of the most shorted stocks on the ASX and the rally yesterday is a reflection the noose is tightening around short sellers. As the oil price appreciates and global peers like US-listed Schlumberger (SLB) and Baker Hughes (BHI) rebound in unison, WOR could easily overshoot all reasonable targets. Many of the mining services companies in the few weeks have surged after completing similar base formation and fueled by short covering. Monadelphous (MND) surged from $8.00 to almost $12 in two weeks, NWH has moved from 25c to 60c, Ausdrill (ASL) rallied from its breakout at 50c to $1.25 yesterday.
WOR is just getting started with its break of $8.00 and could easily reach $11/$12 as shorters look to cover ahead of its profit result next Wednesday. If this sector doesn’t attract, look to Harvey Norman and Myer (the No.1 shorted stock on the ASX) if you are looking to take our advice and rotate from JB Hi-Fi into another heavily shorted stock.