Why Did Electra Battery Materials Stock Price Suddenly Drop?
The plummeting stock
On the morning of June 29, 2022, Electra Battery Materials (NASDAQ: ELBM) has opened since the previous day’s close. Suddenly the price started crashing. In two days, the title lost about 15% of its value. What past?
The event that started around 10:45 a.m. on June 29 is not due to market-moving news, so don’t panic. He is someone who is liquidating a relatively large position. Public information on the fundamentals shows that they are doing well.
The latest company news was good news, and none has come out since my last post.
The company plans to build a second refinery, its management team is strengthening and, despite supply chain disruptions, the company is moving rapidly towards commercial operations which will begin by the end of the year. Latest drilling has revealed additional and highly prospective cobalt deposits within the Idaho mining property. I argued that this strengthens the company’s outlook and aligns with the company’s vertical integration strategy. In this same article, I question the change in Electra’s valuation that would result from ten-year Treasury bonds yielding an additional 100 basis points. I still think Electra is a buy! To buy! To buy! because it remains the North American industry leader in sourcing critical, traceable, low-carbon minerals. As the global economic and political order rapidly evolves, the case for domestic sourcing of 21st century strategic minerals has only grown stronger. These changes have also increased fleet utilization and shipping revenue.
So what happened to the stock?
The daily trading volume of the company’s shares is quite low. So when a computer program sold 150,000 Canadian stocks in the morning, it put such pressure that (even less liquid) US stocks followed, and the circuit breakers were tripped – SEC Short Sale Rule 201 was set. effective 11:32:00 a.m. (UTC-4) Rule 201, the so-called “rise rule,” requires short sales to be made at a price higher than the last trade.
This had the effect of drying up liquidity in the United States, since short sellers could only take a position by “asking” a price and waiting for a buyer to come along. This resulted in less liquidity in the Canadian market, which slowed down the seller. This gave buyers time to consolidate their offers and cushioned the drop in prices.
Rule 201 Slows FX Arb and Liquidity Dries Up
Electra Battery Materials shares are traded in the United States and Canada. Since stocks in either market are equivalent claims on the firm’s equity, they have the same intrinsic value. Since they have the same value but are traded in different currencies, an exchange rate for the currencies is implied by them. If this implied exchange rate deviates from the spot exchange rate (the one prevailing in the broad currency market), then there are opportunities to arbitrage the two exchange rates by simultaneously buying and selling the inter-listed shares and by exchanging currencies. In this specific case, there are arbitrage opportunities when the price ratio of ELBM:CA and ELBM:US shares deviates significantly from the exchange rate of the Canadian dollar to the US dollar (USD/CAD).
This arbitrage operation is important so that the shares are worth the same in the Canadian and American markets.
Although created to stop speculative short selling in an effort to avoid a disorderly market, by enforcing Rule 201 the SEC disrupted the FX arbitrage operation. This explains why liquidity dried up in the US market, since only those who already owned US shares of Electra Battery Materials could “ask” for a price and wait for a buyer to come along – which almost none did. fact, due to the North’s upward selling pressure. Rule 201 aims to prevent speculative bears from taking cash that would be better and more fairly used by investors looking to exit their long positions. The problem is that arbitrageurs who hold no inventory would also be short sellers if they took cash at the “bid price”.
The circuit breaker was tripped at 11:32 a.m. and liquidity quickly dried up in the US as Canadian equities continued to sell off. This resulted in a very rapid deterioration in the implied exchange rate, reaching a maximum deviation of around 6.5% in just four minutes.
A few more trades were made, perhaps between arbitrageurs with stock of US equities or outgoing bulls, and investors with offers in the book, substantially around round number levels like $2.95, $2.90 etc.
Eventually that liquidity dried up and for about 54 minutes the US market stopped trading until someone – who was not a short seller – sold 150 shares at 1:57 p.m. for 2, US$90 each.
An even closer look at the ELBM:US trades shows that the bid collapsed shortly before Rule 201 came into effect. The bid collapse is highlighted in the purple rectangle below. below. Once the upside rule took effect, supply was able to rebuild, even as sellers continued to take liquidity. A few eager buyers came in and took some demand volume (green rectangles below) but as shown in the figure above, only a very small proportion of the volume traded during the 11:33 and 1:57 time period took been initiated by buyers; red bars are seller-initiated transactions. The figure below confirms that sellers have found buyers at round number levels, highlighted in blue rectangles. We can also see that the sell side was unsure of the spread to offer, as shown in the yellow rectangles. This is the behavior of a market participant who senses demand from buyers and tries to avoid selling at a price that is too close to the offer, in case the trade goes wrong – meaning that the price increasing. This should bring comfort to bulls caught off guard in the stock. This is why the yellow boxes show the asking prices (i.e. those for buyers) increasing mechanically. If the selling pressure came from public information material at the company, the demand would be much firmer. As it stands, the demand was a reluctant seller, hoping to make money without strong bearish views. Encouragingly, the offer was quite firm. This should also bring comfort to the bulls.
The seller takes a break
Seeing that liquidity is running out, the Canadian sales program is slowing down. The volume during this period decreases, as shown in the yellow rectangle in the figure below.
Once the bid spread started to fall in the US market, some buyers were tempted and bought. This likely attracted more buyers, filling the supply side of the book; the selling pressure continued until about three quarters of an hour before the close of the day.
It didn’t end on June 29
The next day, the sell program tested the market shortly after the open, as seen in the mechanically increasing volume highlighted in yellow. Satisfied that he found probable liquidity, he started selling again, which he did until about 1:00 p.m. (UTC-4) on June 30, 2022.
Will this continue?
It is possible that this seller will continue to liquidate the position. If I were to guess at the seller’s motives, I would expect them to be based on either portfolio rebalancing needs or private information. I favor the first hypothesis because of the speed of the selloff – so fast it triggered Rule 201 in the US market – and the timing as a month-end and quarter-end date.
Friday, July 1 is a public holiday in Canada (Canada Day) and Monday, July 4 is a public holiday in the United States (Independence Day). During these holidays, the Canadian and then the American markets will be closed. This will result in an overall drop in liquidity and trading volumes until Tuesday July 5th. A well-timed selling program would recognize the weaker liquidity environment and wait, if possible, for the return of willing buyers. This means that it is possible for sustained sales to return after the holidays, especially if Rule 201 is not in effect. However, I think it’s unlikely – or at least unwise to dump Electra’s stock on the available information. In fact, I believe you can get some good stock right now when the company is doing well and prices are depressed.
I don’t expect anyone to have superior private information – but if we see an insider filing in the next few days and before the second quarter financials, now due July 11 – run!