In a typical short squeeze, positive news creates a domino effect. As stock prices start rising, shorts scramble to square off their positions. As more shorts start closing their positions, prices get support. In February, short sellers in companies like U.S. Steel (X) and Freeport-McMoRan (FCX) lost their shirts as a series of positive data points boosted investor sentiment. In this part of the series, we’ll explore what factors could lead to a short squeeze in Alcoa (AA).
As discussed previously, aluminum prices have rallied handsomely over the last two weeks. If prices stay at these levels for some time, markets could start factoring better forward earnings for aluminum producers including Alcoa and Century Aluminum (CENX). Steel is a case in point. Both steel and aluminum are plagued by the same disease, massive global overcapacity. However, global steel prices have risen sharply this year despite not much letdown in Chinese steel exports. Steel has been among the best-performing industrial metals this year, as you can see in the graph above.
One of the investor concerns regarding Alcoa’s split relates to the debt burden. If Alcoa can manage to sell some non-core assets, it would boost its balance sheet. Note that Alcoa is already working on this front and has announced asset sales totaling ~$750 million in 1Q16. A few more asset sales transactions could do the trick for Alcoa. Just for the record, the Morenci stake sale changed Freeport’s fortunes.
Mining stocks have been short sellers’ (SPXU) delight for the last couple of years with the notable exception of 1Q16. Though we have seen a big rally in mining stocks in 1Q16, fundamentals have not improved much. The “risk-on” sentiment has been the key driver of this rally. If the positive sentiment fades away, we could see mining stocks coming under pressure. There are a lot of risks that markets might not be factoring in for some of the mining stocks.
Furthermore, the aerospace sector, which is Alcoa’s key end market, seems to be under some pressure. You can explore more about this in Why Alcoa is Looking at a Bumpy Road Ahead.