Yet again, a stock promoter’s playground has turned into a hedge fund happy house where the fun is fed by retail hubris and institutional apathy.
So how did this fiasco play out? It starts with the heavy promotion of Lake Resources, which has billed itself as a future top five lithium producer, on social media platforms such as Twitter to a cohort of retail punters.
Lithium sector hubris
The promotion was aided by favorable research reports in which the brokers and the authors are paid in stock and options. Social media posts do not always articulate the arrangement.
(In a response to questions, the company said it expected “any firm that chooses to write research on us to make the proper disclosures in their research notes to the market – as they are required to do under their various licenses”.)
This (paid for) enthusiasm for Lake and general hubris in the lithium sector helped catapult the market capitalization to a peak of $3 billion, and eventual eligibility for inclusion on the S&P/ASX 200.
And so, on June 3, S&P Dow Jones Indices announced that effective June 20, Lake, along with another retail favorite BrainChip, plus Core Lithium and New Hope would replace Appen, Codan, Polynovo, Platinum and Tyro in the main benchmark index.
For holders that was great news. It meant a wall of price-agnostic passive index funds and quasi passive super funds would be buying in, bidding up the value of the stock.
But as is so often the case, S&P/ASX 200 inclusion tends to mark the peak in proceedings.
The imminent arrival of institutional owners means that more proxy advisers are called in to examine their corporate governance. And as we have seen time and again, they are aghast at what they find.
Meanwhile, index sensitive institutions (which aren’t always the passive funds) begin accumulating shares in these companies and make those shares available to hedge funds to borrow.
The hedge funds can finally act on their skeptical views by shorting the shares, when it was previously not possible or prohibitively expensive.
That’s exactly what happened in the case of Lake. Short interest ramped up dramatically in the lead-up to the index date, with 45 million shares sold short. Demand is so strong the fee to borrow is about 20 per cent a year.
Sometimes the analysis isn’t all that deep for traders that have seen this story before. One hedge fund said it shorted the shares purely because the company was buying adverts on Twitter – a surefire indication of an egregiously promoted stock.
But even they could not have anticipated the managing director would quit and dump all his stock on index inclusion day, handing them a windfall gain.
The promotion has nonetheless continued. On Wednesday, LKE’s official Twitter account tweeted out research from Red Cloud, which is paid by the company in cash and options, informing investors of a “Buy opportunity on sudden stock dip post-CEO departure”.
“We suspect this is not much more than a human resources issue, perhaps with a difference in opinion on the head office location strategy,” wrote mining analyst David Talbot to rationalize the billion-dollar value evaporation.
So as it stands, the management and stock promoters have made a ton of cash, and so have the hedge funds that subsequently took advantage of what they believed to be an excessively priced stock.
But the retail believers have been rinsed. As have the index tracking funds, more often than not the superannuation funds that everyday Australians have invested in. That is where the cost is borne, not only by the silly among us, but the serious.