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The following chart shows the recent performance of the Baltic Dry Index, which is a composite of several indices that track the daily shipping rates for dry bulk ships of various sizes.

As we see, the BDI has had a rough 2012 so far. After quite a run up in Q4, it tanked to its lowest level in 26 years. Given what we know about what the BDI tracks, we would expect that a falling BDI would signal falling revenues for dry bulk shippers (though, the decline would be lagged to the extent that the shipper utilized fixed contracts). Falling revenues tends to spook the market (especially for an industry that has high fixed costs), so we would expect shares to decline, right?

Here are the stock charts for two of my portfolio holdings, Diana Shipping Inc (NYSE: DSX) and Genco Shipping & Trading Limited (NYSE: GNK):

Genco Shipping & Trading Chart

The key here is that both companies have enjoyed massive returns YTD, with DSX rising 27.3% and GNK rising 38.6% (neither including the AH increase yesterday). So despite a dramatic (historically unique?) decline in the BDI, these stocks have been on fire. What gives?

One possible explanation is that the bottoming out of the BDI led to various short sellers deciding to exit the position. After all, further downside (at least for fundamental reasons) should be somewhat limited. Both stocks were heavily shorted. As of the most recent short data (which I believe is released every two weeks), DSX had 1.757 million shares sold short which represents 4.5 days of volume. GNK had 4.31 million shares short, or a whopping 9.9 days of volume. As fundamental shorts exit and the price begins to rise (by exiting a short, you have to buy shares in the open market to cover your position, leading to upward pricing pressure), the momentum shorts start exiting as well. The consequence, known as a short squeeze, is that the price can quickly rise.

In the case of DSX, another reason for its recent performance might be that it has recently signed several new fixed rate contracts, which should limit its exposure to further erosion in the BDI.

This is one way heavily short stocks can sometimes be a good investment opportunity. We’ve seen the same thing happen with Gamestop (NYSE:GME) and hhGregg (HHG). You can find the companies with high short interest here.

Why do you think DSX and GNK have performed so well? What do you think of heavily shorted stocks?

Disclosure: Long DSX, GNK, GME

Source: Short Squeeze Among Dry Bulk Shippers?