Is this the lithium short squeeze we've all been waiting for?

Many people have been burnt trying to pick the lows of this lithium cycle. However, the recent strength shown by a bellwether name like Pilbara Minerals (ASX: PLS) could be onto something.

Lithium Supply Speculation

Barrenjoey reported an unconfirmed shutdown of CATL's Jianxiawo lithium mine before China's Lunar New Year. CATL (Contemporary Amperex Technology Limited) is one of China's largest battery manufacturers and downstream lithium players.

The battery major was reluctant to continue lithium carbonate production at sub 95,000 yuan (US$13,000) a tonne. This could take out approximately 3% of global supply and shift the market from a 1% surplus to a 2% deficit in 2024. CATL has yet to confirm an official shutdown.

In the last trading session before the week-long Lunar New Year holiday, lithium carbonate futures on Guangzhou Futures Exchange fell 1.4% to 96,300 yuan (US$13,500) a tonne. So the price action doesn't exactly line up with the above shutdown.

Labor Plans Tax Credits

The Albanese government, as reported by the AFR, is fast-tracking a system of production tax credits to try to protect the beleaguered nickel mining sector. The article also notes that the government is prepared to extend the credit to lithium miners, if prices continue to spiral.

Last Friday, Federal Resources Minister Madeleine King placed nickel on the government's official Critical Minerals List. This decision allows companies to tap into additional financing via the $4 billion Critical Minerals Facility and related grants.

Pilbara Minerals and Lithium Stocks

Pilbara Minerals (ASX: PLS) have rallied around 11% since last Friday, to a 5-week high of $3.84. This strength is a little uncharacteristic as previous rallies only occurred after sharp selloffs.

Pilbara Minerals daily price chart (Source: TradingView)

PLS peers such as Liontown Resources (ASX: LTR), Core Lithium (ASX: CXO) and Arcadium Lithium (ASX: LTM) have also displayed similar strength over the past 2-4 sessions.

A Subtle Pullback in Shorts

Pilbara Minerals experienced a slight pullback in short interest from 20.9% on Friday, 9 February to 19.24% on Monday, 12 February.

While it doesn't sound like much at face value, the drop represents the covering of approximately 50 million shares. Still, we have yet to see the 'lithium squeeze' that bulls love to rave on about.

PLS short interest chart (Source: Shortman)

Flight Centre (ASX: FLT) held the title of the most heavily shorted stock in 2020-21. Despite the significant rebound in travel demand post-pandemic, it remains the 10th most shorted stock on the ASX. The journey from approximately 18% short interest to the now 8.0% has taken approximately 10 months. There was no short squeeze. But rather, a gradual unwinding of short positions.

Flight Centre short interest chart (Source: Shortman)

Macquarie's Take on Lithium

China's lithium inventories fell in January due to better-than-expected cathode and electrolyte demand, according to Macquarie.

"The Shanghai Metal Market's latest data shows that China's lithium salt inventory declined for the first time since October 2023, dropping by 6% month-on-month," the analysts said in a note dated 8 February.

"It is still too early to determine whether real demand has improved, since the decline in inventories of both lithium salts is a result of a larger decline from refineries and a slight increase from cathode makers, which suggests a mild restocking from the materials side before the Chinese New Year."

Putting it all together – The lithium sector is enjoying a moment in the sun, with most stocks up around 10-20% over the past couple of sessions. The sector remains volatile and rife with speculation. The dust should settle a little this week as the Chinese market returns from its week-long Lunar New Year holiday. PLS has experienced a small dip in short interest. But we've seen such dips in the past (e.g. shorts eased from 21.2% to 18.48% in late November, only to bounce back above 20% a few sessions later).