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Canadian resource firms beset by predatory hedge funds

Junior miners hope Wall Street Bets movement shines light on naked short-selling in Canada

At the end of January, when silver prices and silver mining stocks took off, it was speculated that some of the same Wall Street Bets investors who drove GameStop (NYSE:GME) stock through the roof were also turning silver into a “meme stock.”

It was a nice bump for B.C. silver miners like Pan American Silver (TSX:PAAS), First Majestic Silver (TSX:FR), and precious metals streamer Wheaton Precious Metals (TSX:WPM). All three had three straight days of rising stock prices, from January 28 to February 1. First Majestic had a whopping 23% increase on February 1.

But if Wall Street Bets investors were indeed behind the soaring silver prices and stocks, and if their plan was to do to silver what they did for struggling retail companies like GameStop, by now they may have already begun to realize just what they are up against.

“Good luck with that,” said Mickey Fulp, publisher of the Mercenary Geologist. “You’re not fighting hedge funds. You’re not fighting Citadel and Melvin [Capital] – you’re fighting the world’s biggest banks.”

No sooner had silver prices jumped to US$30 per ounce at around 9 a.m. on February 1 than bullion banks “slammed” the prices down by US$2 per ounce, said Russell Starr, whose junior gold mining company appears to have been the victim of naked short-selling.

He is thrilled to see the Reddit investors pushing up silver prices and mining stock. But like Fulp, he’s not sure how long a silver bull can run on the momentum of millennials playing with stock on free trading platforms like Robinhood.

“What’s happening now in the retail market is they’re going after the silver shorters, who are basically bullion banks,” said Starr, a former Bay Street trader, co-founder of Echelon Wealth Partners and now CEO of Trillium Gold Mines (TSX-V:TGM).

“What the retail crowd doesn’t understand is that they can bring a 100 million people with $1,200 cheques to the table, but they’re fighting someone who can sell billions of dollars in their face. It will be very interesting to see if these retail guys can even stand a chance against JP Morgan.”

At the very least, junior miners and the retail investors who invest in them hope the whole Wall Street Bets phenomenon will shine a light on what they say is a serious problem for Canadian resource companies and Canadian capital markets in general: predatory trading by big hedge funds that disproportionately target Canadian companies.

“We’re finally in an environment where we actually have a chance to be heard, whereas a year ago the regulators never would have listened,” Starr said.

Starr pointed to his own company as an example of what happens all the time with gold and silver companies. Trillium was recently shorted “without a borrow.”

In other words, Starr said someone had short-sold Trillium stock without actually borrowing the stock. This naked short-selling is when someone short-sells more stock than exists. Another form of manipulation is spoofing, when high-frequency traders feign interest in stock or commodities they have no intention of buying.

Both are technically illegal in the U.S., but happen all the time, and the fines handed out for selling phantom stock haven’t stopped the practice.

And in Canada, it appears to be either quasi-legal or poorly policed. The Investment Industry Regulatory Organization of Canada (IIROC) says naked shorting is illegal in Canada. But it isn’t, according to the business law firm McMillan LLP, which did a study on short-selling in 2019, and concluded that “despite IIROC’s insistence to the contrary, naked short-selling is legal in Canada.”

In 2012, Canadian securities regulators eliminated the uptick rule, which meant someone could bet against a stock – that is, short it – only when the stock price was moving up. Now, any stock can be shorted, and the problem is compounded by algorithm-based high-frequency trading technology.

Terry Lynch, CEO of Chilean Metals Inc. (TSX-V:CMX), said short-selling serves a legitimate function in the market, when it is used to identify truly bad companies or asset bubbles and dissuade people from investing in them. But when it is done strictly for profit through what is essentially market manipulation, it benefits no one except the hedge funds and brokers.

Last year, Lynch started the Save Canadian Mining campaign and commissioned Murenbeeld to perform a study. The research found that prior to 2012, when the uptick rule was still in place, junior mining stocks on the Toronto Stock Exchange and venture exchanges generally traded on par with the metals commodity index. Now Canadian mining company stocks trade at about 35% to the commodity index, Lynch said.

Short-sellers sell stock they don’t own – they borrow it from a broker. They typically release statements explaining why they think the stock is overvalued, in the hope others will sell their stock in that company.

By the time they must settle with the buyer of the stock they borrowed, they are gambling that the stock will have gone down, so they can buy it a lower price, then pocket the difference.

Naked short-selling is when stock is sold without even borrowing it – basically selling stock that is in excess to what is outstanding.

“If you actually did it legitimately, you can’t sell what doesn’t exist,” Lynch said. “But that’s exactly what’s happened to many of these issuers.”

In Canada, short-sellers can sell stock they didn’t even borrow, as long as there is a reasonable expectation that they will be able to settle the trade, the McMillan study points out.

“At its worst, naked shorting can be a tool for unscrupulous short-campaigners deliberately spreading misinformation to drive down the target’s share price,” McMillan warns.

The McMillan study concludes that, because of Canada’s lax regulations, Canadian capital markets have been lopsidedly targeted: “The number of short campaigns in Canada is disproportionate to the number occurring in the United States, given the relative sizes of their respective markets.”

Lynch said the Capital Markets Modernization Task Force in Ontario has come up with some recommendations for tightening the rules on short-selling in Canada. While it doesn’t go as far as recommending the reinstatement of the uptick rule, Lynch said some of the recommendations – if adopted by regulators – should at least make it harder to short Canadian stocks.

“If they follow up on the recommendations, it would help a lot,” Lynch said.

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