3 Things The Reddit Crowd Should Know About Short Stocks Vs. Commodities

The Reddit r/WallStreetBets crowd has turned their sights from short squeezing stocks to short squeezing commodities. Here are three important differences they need to know.

Speculative Stock Shorts are Different Than Hedged Futures Shorts

This is really important. Hedge funds aren’t really hedgers at all, at least not in the commercial sense of the word. Hedge funds and other speculators who decide a company is overvalued and then short the stock in the hope of making speculative profits are not hedging anything – they are speculating. As the stock rises, the short must be covered literally in order to survive. The higher prices go, the more losses build up, until eventually all is lost. The speculative short MUST cover.

Not so for futures shorts made by actual industry hedgers. A short futures hedge is when a short futures position is offset against an asset that is owned, usually locking in a profit margin. If a mining company or bank owns silver at, say $20 per ounce, and they short hedge (sell a silver futures contract) at $25 per ounce, they have locked in a five dollar margin. As prices rise, there is a gain on the physical silver owned that offsets losses on the futures short position. The short position does NOT have to cover because the five dollar margin remains intact no matter how high prices rise.

Shares Outstanding of a Stock Versus Open Interest in Futures

The number of shares outstanding in a company with a listed security is finite at any given point in time. It’s easy to see how much short open interest versus outstanding shares (the float) there may be, and buying demand will push prices higher due to the limited number of shares available for both buyers and sellers to trade.

The same is not true in futures markets, where whenever a buyer and seller are matched on price, a new futures contract is created. There is no limit to the number of futures contracts that can be created, which means any “squeeze” that occurs will not be due to lack of futures contracts, but rather to a lack of supply of the underlying commodity.

Commodity Markets Like Silver are Massive, Integrated, and Efficient

Commodity markets are real. Real assets, real businesses, real people. Tenacious, survive-in-any-circumstances type people. Being up against these folks is a world apart from squeezing a billionaire hedge fund titan with a team of geeky analysts out of a weak short position in a shaky company.

Commodities are an industry; and the industry loves higher prices. Thinking you can squeeze miners, bankers, and other silver industry participants out of short hedges by buying physical silver? Think again. The market will go up for sure, because ultimately commodities are a supply and demand driven business. The industry professionals will love you for boosting prices. You won’t be taking any money from them, they’ll be happily taking it from you – it’s their job. They will be thrilled to use your money to create more efficient ways to mine more silver, find more silver, and sell more silver far into the future.

Silver is going higher, but not because of a short squeeze forcing people to cover. The buying of physical silver is creating more demand, which will make prices rise, but only until supply catches up with demand. That supply will come from commodity professionals who don’t fear higher prices – they welcome higher prices with open arms.