Short-selling gold signals

Gold stocks have recorded the most reductions in short-selling positions, thanks to the rising gold price.

The trend in short-selling activity often gives an early signal on the direction of share prices. So investors should sit up and take note of the recent sharp changes in short interest among emerging stocks.

These changes in short positions, which refer to the selling of borrowed stock by traders betting on a share price decline, come amid the flood of earnings news and threats of escalating violence in the Middle East.

The sector that has recorded the most significant change in the short-selling trend over the past month is gold equities, according to the latest figures by the Australian Securities & Investment Commission (ASIC), which are a week old.

The data showed that short-sellers were buying back stock to close a significant number of short positions in Regis Resources (RRL), Saracen Mineral Holdings (SAR), Medusa Mining (MML) and Papillon Resources (PIR). These stocks are among the top 20 names that have seen the greatest reduction in short positions.

The 19% rebound in the gold price over the past two months is the key driver for the change in sentiment towards the embattled sector, as there is growing confidence that the free-fall in the spot gold price from October last year is over.

Short-sellers must be sweating as the gold sector has been their favourite playground after doubts emerged about the asset’s ability to hold its value in the economic turmoil.

But gold has not only remained above the support level that is defined by the average cost of production (it is estimated that a gold price below $US1,000-$US1,200 an ounce would force major gold miners to cut back significantly on production, leading to a shortfall in supply), some believe a United States-led military intervention in Syria would push the precious metal significantly higher.

I believe gold has found a floor since hitting a low of $US1,200 an ounce in late June, but don’t hold your breath for a quick gold spike on a US strike, if history is any guide.

Looking at the past three significant US conflicts in the region – operation Desert Storm to free Kuwait in January 1991; operation Enduring Freedom to rid the Taliban from Afghanistan in October 2001; and operation Iraqi Freedom to oust Saddam Hussein in March 2003 – gold rallied in the days before the first US bombs or missiles are released, but the start of the campaign can prompt profit taking.

Any expansion of the warfare in Syria will not guarantee a higher gold price. The only real certainty is volatility.

I don’t think we will see much of a sell-off in gold as the commodity looks to be well supported on dips, but if the yellow metal moves higher in the coming months, it will probably be driven more by a slower-than-expected tapering of the US Federal Reserve’s $US85 billion a month bond buying program instead.

The wind-back of short positions adds to the argument that things are looking brighter for gold equities, as WilsonHTM Investment Group strategist, Damien Klassen, believes short sellers tend to get more of their trades right than wrong.

“You hear about the notable failures more than the successes, as there is a powerful narrative when the short-sellers do get squeezed (or forced to close positions as the stock moves against them),” says Klassen.

“It is more expensive to ‘short’ a stock than to [buy] a stock, so there is a higher conviction when somebody goes short as they are paying for the privilege.”

He highlighted Australia’s largest listed gold producer, Newcrest Mining (NCM), as an example. Klassen recommended investors sell Newcrest before the June sell-off, as it went from being the least short-sold stock on the S&P/ASX 100 to the average in just a couple of weeks.

There are two key things in the short-selling data investors should watch, adds Klassen. The first is the absolute amount of stock that is short-sold.

“The other is changes in the direction and trajectory [of short interest] and I think that has actually been a bigger influence [on share prices],” he says.

Beadell Resources (BDR)

While Saracen Mineral saw the biggest reduction in shorts among Uncapped 100 stocks, with the percentage of short-sold stock to total shares falling 1.43 of a percentage point over the month to 2.12%, the gold miner that I find more interesting is Beadell Resources (BDR).

The proportion of shorts in Beadell may have fallen a more modest 0.7 of a percentage point since July 22, but the drop is significant as Beadell is the second-most shorted gold miner on the ASX. This means a relatively small percentage change in shorts would translate to a relatively large number of shares being bought back by short-sellers.

Further, I suspect it is getting harder for short-sellers to borrow Beadell stock. According to ASX data, the amount of Beadell stock that is currently shorted stands at 76% of the total stock available to short-sellers. The amount of stock available is different for each company as it depends on how much stock institutional investors are willing to lend out.

Based on the average daily turnover of Beadell stock, it would take short-sellers 10 days to replace the borrowed stock, and all these factors mean Beadell is in a good position to enjoy a short squeeze, where short-sellers have to rush to buy the stock, which forces the price up.

It takes a brave trader to open a fresh short position on Beadell under these conditions, especially when the factors that have made the gold miner such a favourite short target are easing.

Beadell’s financial health had been under a cloud due to debt and unexpected delays in mining its Duckhead deposit at its Tucano mine in Brazil.

The miner needs to sell gold from Duckhead to repay debt, with $US7 million due next month and $US32 million due by end of the calendar year. Beadell has a further $US62 million it needs to repay in 2014.

However, Beadell reassured investors yesterday with news that mining at Duckhead has started, and if all goes according to plan it will have little trouble repaying debt and will start delivering a sustainable dividend next year.

I believe the stock will be re-rated when it closes in on that important milestone, even though the stock has already jumped 73% in the past two months and is closing in on the average broker price target.

I highlighted Beadell on May 29 as one of the stocks in the Uncapped 100 facing a game-changing year in 2013-14 and the stock has surged 36% to 88.5 cents since. I think the stock is still worth buying at current levels for a few reasons.

First, 60% of its gold output in the 2014 calendar year from Tucano is hedged at $US1,600 an ounce, which is well above the current gold price. Tucano is a long-life asset, with an estimated life of around 10 years.

More importantly, Tucano is a very low-cost mine. Cash cost is estimated at under $US500 an ounce, and while management has not provided total sustainable costs, I believe a gold price over $US1,000 will give it a comfortable margin.

There is good exploration upside potential too, and the stock is also cheap given that its enterprise value to gold assets of $178 an ounce is less than half that of it global peers.

eServGlobal (ESV)

On the flipside, mobile payment solutions company eServGlobal (ESV) has seen a big increase in short interest over the past month.

Traders may be betting against the company on the back of growing geopolitical tension. It is not only Syria but the civil unrest in Egypt that could drag on company profits, as Africa and the Middle East account for around 70% of group revenue.

eServGlobal’s Paris-based chief executive, Paolo Montessori, said in an emailed statement to Eureka Report that the company has been busy diversifying outside the region and played down suggestions that its revenues could be under threat.

“In regards to Syria in particular, our customer here has paid for the maintenance in full and we do not project any requirements for upgrades/expansions, nor are we forecasting any,” he says.

“This is the same situation for our customer in Egypt. Our customers are continuing to pay maintenance, which we manage via remote connections.”

eServGlobal is one of the more exciting small caps to watch as it has achieved critical mass with 1.2 billion subscribers in developing and emerging markets. The company also looks poised to return to profit in 2013-14 for the first time since 2008.

However, I believe investors should wait for a better entry price based on four assumptions. The first speaks to the fact that the stock has surged 132% to 44 cents over the past 12-months and looks to be losing momentum.

Technical analysts would also point out that the stock is hitting its head against key resistance at around 46 cents. The stock has tried and failed six times over the past year to break above this level.

The third is the increase in shorting activity, and shorting interest could persist for a while yet. Lastly, a fair amount of good news appears to be already factored into the share price as the stock is trading on a 2013-14 price-earnings multiple of 44 times.

I won’t be surprise to see the stock consolidate around the 35 cents to 40 cents level before breaking higher. Watch this space.

Think big, go smalls!

Brendon Lau does not own shares in BDR or ESV.

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Uncapped 100 - Australia's most interesting small cap stocks

Small cap stocks covered by the Uncapped team
CodeNameRationaleMarket cap ($m)Total return 1-year (%)Sector (GICS)
BRG Breville Group Well covered but good candidate for core holding due to good track record.1,127,926,39266.79Consumer Discretionary
MTU M2 Telecommunications Group Amazing growth story and well run company. High free float and strong insto support.1,099,552,73479.68Telecommunication Services
NHF NIB HoldingsOnly listed health insurer. Widely held. Good performer.943,859,00939.85Financials
ARP ARB Corp Well covered but good candidate for core holding due to quality management.898,768,12728.7Consumer Discretionary
MRM Mermaid Marine Australia Its strategically located facility on WA coast gives it a key advantage over competition in servicing Gorgon & Pluto projects.886,719,36020.25Industrials
MMS McMillan Shakespeare One of the best performers since the GFC, but change to FBT rules is threatening growth.861,497,0701.89Industrials
GEM G8 Education Only listed childcare operator. Acquisition strategy paying off with stock delivering solid gains.748,541,321144.84Consumer Discretionary
SRX Sirtex Medical A shining star in the biotech space and one of the best performing stocks in 2012. Great product (liver cancer treatment) and bright outlook.723,430,54273.75Health Care
AAD Ardent Leisure GroupWidely held stock. Earnings more defensive than anticipated. Good yield. Potential core holding.721,456,78751.52Consumer Discretionary
BDR Beadell Resources Will be a very big FY14 for miner as it has to prove it aims to produce 200,000 ounces of gold a year.681,859,8638.81Materials
AUB Austbrokers Holdings The insurance broker is a strong performer. Widely held and well liked by small cap investors.644,290,71045.56Financials
SGN STW Communications Group One of few companies able to benefit from online shift. Widely held and good insto support.629,972,47354.12Consumer Discretionary
ACR Acrux One of the most successful Australian biotechs in recent history. Widely held by instos.556,182,4957.68Health Care
RFG Retail Food Group Owns a number of well know franchise brands. Widely followed by instos.532,931,88549.21Consumer Discretionary
CCV Cash Converters International Strong performance is attracting investors. It's Australia's only listed pawn shop and pay day lender.517,110,47463.56Consumer Discretionary
NXT NEXTDC The cloud computing company is an IT sector darling. Fairly widely held and followed.497,097,50427.78Telecommunication Services
SEA Sundance Energy Australia Analysts have a favorable take on the oil & gas explorer, but stock is still under radar of most. Sundance provides exposure to prospective Eagle Ford shale.494,994,84350.7Energy
BRU Buru Energy Substantial size but not often covered by press. Widely held with good insto support.491,735,138-40.11Energy
CWP Cedar Woods Properties Property developer with good ROE and earnings growth track record.472,435,51676.21Financials
CCP Credit Corp Group Strong price run attracted good investor interest. Leveraged to any rise in loan defaults. Not well covered by press.463,922,30264.76Industrials
BGA Bega Cheese Corporate interest in Australian food companies makes the cheese maker worth following.461,672,79184.15Consumer Staples
TOX Tox Free Solutions Widely held stock in the waste solutions business. Its unique because it operates in a defensive-growth niche.458,518,70732.13Industrials
HZN Horizon Oil One of better regarded small energy stocks that doesn't receive much media attention.454,106,59814.45Energy
AMM Amcom Telecommunications Well covered junior telco but good candidate for core holding.453,653,41259.76Telecommunication Services
FGE Forge Group One of the better performers in its industry. Good track record and potential core holding.452,387,32918.8Industrials
SLX Silex Systems Its uranium enrichment technology could become one of Australia's best innovations given its potential to change the nuclear power industry.429,027,863-35.38Information Technology
RCR RCR Tomlinson Good first half FY13 result and outlook, but will its fortunes change this year with the mining capex slowdown?415,496,91880.66Industrials
MYS MyState Well regarded and could make good alternative to bank stocks. Has good yield and earnings growth over past few years.408,747,80351.09Financials
NWH NRW Holdings One of the better regarded mining & civil contractors with good track record in delivering on projects.343,032,257-53.78Industrials
UXC UXC Company has turned corner and enjoyed re-rating. What's next?339,797,45550.59Information Technology
TGA Thorn Group One of few retail stocks that is performing well. The Radio Rentals chain owner is also well supported by instos.335,018,58534.39Consumer Discretionary
UNS Unilife CorpThe developer of one-use prefilled syringes is close to an inflection point as the market is expecting the company to announce a major contract with a pharmaceutical giant in the coming weeks.317,430,81719.35Health Care
MOC Mortgage Choice Has a good track record and is leveraged to any housing recovery. The stock is also liquid with good insto support.299,938,01977.62Financials
MYX Mayne Pharma Group Sizeable generic drug maker with interesting board members.298,633,75994.69Health Care
RKN Reckon Fierce competition for cloud base accounting software puts it in firing line.291,348,0227.13Information Technology
SPL Starpharma Holdings Noteworthy for its good pipeline of innovations. Well run, widely followed.282,445,618-33.67Health Care
AEU Australian Education TrustWell performing childcare centre property owner. Good yield story and outlook. 275,480,68246.91Financials
RIC Ridley Corp High corporate interest in the sector and the shrinking pool of agri listed stocks make Ridley worth following.252,409,988-13.6Consumer Staples
GID GI Dynamics IncLargely forgotten by investors but could attract attention this year as it looks to gain US approval to use its intestinal shealth on diabetics.251,440,186-12.2Health Care
SHV Select Harvests Noteworthy for turbulent past and exposure to soft commodity market.247,090,271250.91Consumer Staples
BNO Bionomics One of the larger cancer treatment developers in this market.246,885,712101.18Health Care
IMF IMF Australia Litigation funder is unique stock. Stock not liquid but its outlook appears promising given the number of potential class action lawsuits.243,954,55938.46Financials
NAN Nanosonics A successful medical tech story. Should be close to turning in maiden profit with its disinfection device.232,037,01880.61Health Care
MXI MaxiTRANS Industries Transport equipment maker posted good interim result. Has appealing yield and growth.231,831,66568.2Industrials
SIV Silver Chef Strong jump in the share price of the equipment financing group has attracted a good following.228,951,447113.78Industrials
AJA Astro Japan Property GroupStrong leverage to Japanese economy makes this an interesting stock to watch.226,503,60121.48Financials
IPP iProperty Group Worth watching as it is trying to be the REA Group of Asia.214,050,14019.19Information Technology
GXL Greencross Acquisitive vetinary group. Good profit growth and share price performance, but gets little press.201,579,83492.44Health Care
DWS DWS Will be a big beneficiary if governments start spending on IT again.200,529,587-1.38Information Technology
NWT Newsat Potential large cap if it can launch its own satellite in 2015.196,948,273-35.71Telecommunication Services
CLH Collection House In similar space as Credit Corp. Strong stock performance has attracted a following and the stock appears to be well placed to run further193,358,21585.94Industrials
PFL Patties Foods Illiquid stock but has suite of well recognised consumer brands. Defensive yield.193,301,239-7.67Consumer Staples
IFM Infomedia Interesting tech play in the car parts market. Strong share price gain but gets little air play.185,899,429185.08Information Technology
DTL Data#3 Well respected IT company that receives little press coverage.183,230,1946.72Information Technology
HSN Hansen Technologies Operates in a high potential/growth industry but is not covered by press or brokers.182,399,55132.8Information Technology
WBB Wide Bay Australia The building society is trying to turn its fortunes around. Also worth watching for its exposure to Queensland housing market, particularly around major resource projects.181,192,993-23.27Financials
VOC Vocus Communications Telecom stocks are in favour but Vocus is one of the least covered174,489,97530.23Telecommunication Services
SAR Saracen Mineral Holdings Emerging gold producer that is widely held by instos. Hitting milestones and looks cheap. Key asset is close to gold majors, which makes it a potential takeover target.172,626,312-28.4Materials
SFH Specialty Fashion Group In early stages of turnaround. Can the women's apparel retailer sustain the momentum?169,167,78679.57Consumer Discretionary
TGS Tiger Resources Future lies in its Kipoi copper mine expansion in the Congo but miner is fully funded with DRC govt holding 40% stake in tenement. Next 12mths will be interesting.168,692,566-21.88Materials
CKF Collins Foods One of the few food franchise listed companies.167,399,99467.58Consumer Discretionary
RCG RCG Corp The footwear retailer is one of the best performing consumer stocks as online competition is not a big threat. Company has a good yield as well.160,987,65679.42Consumer Discretionary
IMD Imdex Drilling company is well supported by instos and should benefit from any rebound in exploration activity.144,174,133-57.38Materials
MLB Melbourne IT A perennial underperformer could be interesting turnaround story as management is in midst of restructuring the business.134,801,1935.87Information Technology
ACL AlchemiaOne of the few biotechs with revenue stream. Good pipeline of oncology treatments.132,857,971-18.81Health Care
REX Regional Express Holdings Well run airline that is overshadowed by Virgin and Qantas.132,107,31513.8Industrials
TFC TFS Corp The sandalwood products company offers exposure to both the agri and cosmetics industry. It will start commercial harvest this year.131,422,25616.05Materials
AZZ Antares Energy Liquid with good insto support. Already in production with exploration upside in Texas.128,774,99423.17Energy
MCP McPherson's The personal care and household products supplier had been relatively insulated from volatile discretionary spend and online threat, but its latest profit warning shows it's not immune.126,351,288-18.05Consumer Discretionary
UBI Universal Biosensors IncWell regarded biotech and one of few that's successfully manufacturing in Australia. Struck deal with a few global medical companies.120,549,50015Health Care
BGL BigAir Group The wireless microcap has gained strong following over past year or two but is often overlooked by investors and the press.119,698,87570.04Telecommunication Services
AMA AMA Group Good turnaround story but under the automotive services group is radar of most.116,283,18882.87Consumer Discretionary
LCM LogiCamms Strong price performance and reasonable valuation attracting interest.114,952,75945.44Industrials
NEA Nearmap A stellar performer with an Interesting business that offers high quality ariel maps to companies & government.109,839,073871.43Information Technology
ESV Eservglobal Mobile money transfer company that has been gaining traction. Widely held by instos but low press coverage109,580,238131.58Information Technology
WDS WDS Widely held with strong insto support. Engineering contractor diversified across mining, energy and infrastructure.108,555,45820.97Industrials
DRM Doray Minerals Widely held by instos. One of the more favored gold explorers by brokers.104,272,0793.85Materials
POH Phosphagenics Sizable biotech with a game changing FY14 year ahead. Good insto following but questions of poor audit and governance standard could dog company.100,005,661-27.41Health Care
CLV Clover Corp One of the star performers in 2012. Operates in growing but relatively stable niche.90,849,93724.51Health Care
JIN Jumbo Interactive Innovative small cap facing off industry dominated by giants. Worth watching to see if it can carve out a profitable global business.90,153,79347.69Consumer Discretionary
AOH Altona Mining Noteworthy copper play with Xstrata pullout of Roseby project in Australia and the good ramp up of its Finnish project.82,488,632-46.55Materials
PEN Peninsula Energy Widely held by instos and large free float. It's the only uranium miner on the list.79,919,868-6.9Energy
RUL RungePincockMinarco IT company to resource industry. Facing tough operating climate with new CEO trying to restructure and turnaround company.70,672,60745.5Industrials
LGD Legend Corp Electronic parts supplier to utilities and other industries. Stable earnings with good yield. Often overlooked.68,045,082-8.21Information Technology
GXY Galaxy Resources Good upside potential if it can get its problem-prone Jiangsu plant back on track. Won't be easy to right this ship.67,211,845-74.56Materials
CAA Capral An aluminium manufacturer that is actually holding up relatively well given that manufacturing is on the nose. 67,108,90213.33Materials
CUV Clinuvel Pharmaceuticals Interesting skin disorder treatment developer that has done reasonably well over past year66,115,47911.25Health Care
CKL Colorpak The small cap packaging company has grown via acquisitions over past few years.66,045,09058.82Materials
TAN  Tandou The only direct equity exposure to cotton prices. Also trades water rights and receives little press.65,855,34727.68Consumer Staples
BOL Boom Logistics Crane hire group is riding out the downturn in construction.  It's widely held by instos and is very liquid.63,530,811-64Industrials
TSM ThinkSmart Potential turnaround story worth keeping eye on.57,619,019102.86Financials
YTC YTC Resources Next 12-mths will be eventful after YTC secured funding for its projects from Glencore.56,474,026-30.65Materials
UML Unity Mining Growing Tassie gold producer with high free float. Valuation looks compelling too.56,159,824-33.33Materials
KOV Korvest The construction products and services supplier has been hit by project delays and deferrals. But its relatively high yield could give it some support.48,040,9894.61Industrials
OTH Onthehouse Holdings Alternative small cap to online property leader REA Group. It is trying to use more timely housing data as a compeitive edge against REA.39,443,96615.29Consumer Discretionary
EBT eBet Potential alternative to star performer Ainsworth Tech. Has exclusive deal with US poker machine maker WMS.37,543,915191.67Consumer Discretionary
NTC NetComm Wireless Under appreciated small IT hardware maker that is punching above its weight. Hardly covered by press.29,559,576100Information Technology
MBO Mobilarm Unique product that could change global maritime safety practices with its man-overboard location beacon.17,117,69179.91Information Technology
PGC Paragon Care Emerging hospital equipment supplier that has been ignored by market.14,291,80957.14Health Care
ISS ISS Group ISS delisted on Aug 9 after being acquired by by P2ESn.a.n.a.Information Technology
Source: Eureka Report, Bloomberg

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