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  1. Home
  2. / Investing
  3. / Energy

Short-Interest Tables Show Traders Are Watching the Wrong Stocks

It's just as dumb to short energy companies as it is to short mining companies.
By JIM COLLINS
Oct 26, 2016 | 09:00 AM EDT
Stocks quotes in this article: SPY, F, S, VALE, FCX, BHP, CHK, RIG, SDRL, DNR

One of the ways we contrarians amuse ourselves -- and find stock ideas -- is by surfing the short-interest tables. The most recent data were published Tuesday in The Wall Street Journal. As always, it's intriguing reading. 

Starting with the top-down view, the data paint a picture of a market that is just rife with complacency. NYSE short interest fell 1.4% from Sept. 30 to Oct. 14. Short interest on Oct. 14 stood at 16.371 billion shares, down from the prior reading of 16.608 billion. The most shorted security, as usual, was the bellwether S&P 500 Index ETF (SPY) , but short interest on the SPY actually rose 7.7% from Sept. 30 to Oct. 14. 

So traders are paying attention, I just think they are paying attention to the wrong stocks. After Ford (F) and Sprint (S) , the No. 4 and 5 positions on the NYSE short-interest table are occupied by Vale (VALE) and Freeport McMoRan (FCX) . I've written about mining stocks for Real Money in the past few months, and it was quite clear to me after viewing half-year results from the likes of Vale and BHP Billiton (BHP) that the mining industry is in the midst of a secular recovery. (Ford is part of TheStreet's Dividend Stock Advisor portfolio.) 

So why are so many traders shorting Vale and Freeport? Shorting can be a hedging technique and is not necessarily a bet against a company, but when one analyzes basic materials companies, a short is almost always a negative bet. Shorting is expensive to do, and those who do it are often dead wrong. In the case of Vale and Freeport, I believe that will be proven over the next few months. 

Traders also seemed to have missed the nice run crude prices have made back through the $50-a-barrel mark. I understand some hesitation to back this rally after so many head fakes in the past two years, and, of course, any movement based on the idea that OPEC members will actually limit production (as opposed to just agreeing to do so) should be viewed with skepticism. 

But $50 oil is being driven by solid demand statistics and heavy Chinese imports more so than the machinations of Middle Eastern governments. So I think it's just as dumb to short energy companies as it is to short mining companies, but some market participants obviously disagree with me. 

Looking at the NYSE short-interest list, one sees Chesapeake (CHK) at No. 9, Transocean (RIG) at No. 11, Denbury Resources (DNR) at 16 and Seadrill (SDRL) at 17. Again, I think traders are missing the point here. Oil prices have recovered, and I believe that is a sustainable factor. 

That's where the contrarian bent comes into play. A high level of short interest can act as rocket fuel for a stock's recovery. While stocks like CHK have increased by magnitudes since the February lows, these short-interest figures indicate to me that here is more upside ahead. 

So I'll be doing more work on those six names with an eye toward adding them to my clients' portfolios in November. It will certainly be an interesting month, and one that will see a World Series championship return to a club for the first time in either 68 or 108 (!) years. Sometimes the out-of-favor losers have their day, and I believe that is the case for heavily shorted stocks just as it is for the Cubs and Indians.

Get an email alert each time I write an article for Real Money. Click the "+Follow" next to my byline to this article.

At the time of publication, Collins had no positions in the stocks mentioned.

TAGS: Investing | U.S. Equity | Energy | Basic Materials | Telecom Services | Short-selling

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