10/11/11: Short Update

Demand for First Solar’s (NSDQ: FSLR) thin-film solar modules depends primarily on the government’s largesse. Fiscal austerity is the watchword for many governments in the developed and developing world. That’s particularly true in Europe, the erstwhile driver of the alternative energy boom. Italy, Spain, Portugal and Greece were once champions of solar and wind technologies; now, these nations will focus on trimming government debt.

During an Oct. 4 speech, Chancellor Angela Merkel hinted that Germany may cut its feed-in tariffs for solar power by more than the currently expected 15 percent. Germany is a huge market for solar power, but the mounting costs of these tariffs on consumers are unsustainable.

Despite reduced subsidies and demand, solar-power equipment manufacturers have added capacity in recent years, gearing up for an anticipated boom in demand. This glut of solar equipment has depressed prices and profit margins significantly.

Some of the industry’s weakest names have already declared bankruptcy. Solyndra, a private outfit that went under about two years after receiving $535 million loan guarantee from the Dept of Energy. Evergreen Solar, a former high-flyer whose stock fetched more than $103 per share in late 2007, filed for bankruptcy in August. Energy Conversion (NSDQ: ENER) is also on the verge of bankruptcy.  

Some stocks in the group will survive, but industries that have caught up in a bubble take time to heal.

Investors should cover their remaining short position in First Solar because short interest in the company accounts for about 40 percent of its float. We do not want to risk getting caught up in a short play–particularly when we have a 55 percent gain on the table. A short squeeze occurs when traders cover their shorts by buying back stock, sending the stock higher. Because of this phenomenon, heavily shorted names often post dramatic but short-lived rallies during bear markets.

Shares of First Solar could drift 5 percent to 10 percent lower, but the risk of a 20 percent to 30 percent rally increases if the market strengthens during earnings season. Cover your remaining short position in First Solar and book a 55 percent gain.

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