GameStop: A Ponzi-like Market Manipulation: (EP. 303)

Introduction

Manipulating stock markets, attempting to make money independent of any realistic valuation of the stock in question, is deeply wrong, and creates stunning amounts of damage. Most often to the little guy. That’s what’s happening with GameStop.  

That is the subject of today’s 10 minute episode.

Continuing

What is behind GameStop is market manipulation, more specifically a pump and dump. More than a little reminiscent of a Ponzi scheme or a chain letter. 

The mythical Robin Hood took money from the ruthless, undeserving rich, and gave it to the downtrodden and disposed. The Sheriff of Nottingham was the strongarm for Prince John, the embodiment of the evil, undeserving rich.

Today, Robin(hood), an online broker, offering a no-fee way to buy and sell stocks, and its band of Merry Day Traders, orchestrated a short squeeze, with the avowed intention of simply punishing hedge funds, today’s Sheriff. With today’s Prince John presumably being the “system” which is always unfair to the little guys. 

Here’s the scene that many imagine when we think of GameStop. The hedge fund pro shows up at work, having been driven there by a car service. His grande latte is handed to him as he heads to the conference room, filled with massive computer screens and data analysts. His boss, a Goldfinger type, announces that they are going to make billions by shorting GameStop (GME). And off they go. The lonely day trader is sitting at his kitchen table, home from work because of COVID, using his Chromebook to look around for something he can afford to buy that might allow him to make a few dollars. And miracle of miracles, the day trader wins, makes tens of thousands of dollars while beating the hedge funds at their game. That’s a fun scenario, and it brings a smile to my face. We all love a successful underdog. And we’ll get back to this.

Let’s take a pause for some definitions: 

• Hedge Fund. Big, private money.
• Short selling. A bet that a stock is overvalued and will go down. Short sellers, “shorts”, borrow shares, then sell them, contracting to give them back at a certain date–plus interest. If the stock goes down, the shorts make the difference between the price of the stock when sold and the lower price when they bought the contracted number of shares to return to the lender. 
• Going long. Betting that a stock will go up. This one is simple: buy the stock you feel is undervalued, then wait and see.
• Short Squeeze. If a shorted stock starts to rise rapidly instead of falling, the shorts will scramble to buy enough stock to cover their positions. The shorts scrambling to buy drives up the price, and encourages others to jump in and buy as well. This can cost the shorts stunning amounts of money. Here is an example. If you buy 1M shares of stock at, say $4, the most you can lose is $4M. If you short the same $4 stock, and it rises to $104, the loss is $100M. 
• Honest stock buying and selling. Putting your money down, betting that you have correctly assessed a stock to be either overvalued, or undervalued. 
• Stock manipulation. Using the power of large amounts of money to push the price of stock either up or down, entirely independent of what you feel the real worth of the company’s stock to be in the market. 
• Pump and dump. Big money buying heavily into a stock with the intention of driving it up well past its real value–then dumping it for a huge profit. Ignoring and not caring for the people who lost as much as you made.

Short selling is an honest way to make money if you believe a stock is overvalued. Additionally, it sends a useful signal to anyone paying attention that the stock in question may be overvalued. Going long is also an honest way to make money if you think a stock is undervalued. And it, too, sends a useful signal to the market.

Now, let’s look at some facts about GameStop as published by the Wall Street Journal: 

• “The stock rose over 1,600% in January. People are claiming to have become overnight millionaires. For some, there is the bonus incentive that all the craziness seems to be part of a movement to stick it to Wall Street.” 
• “First, be clear about what GameStop is and isn’t at this point. It isn’t an investment. It isn’t a trade. It is a gamble, pure and simple. That means you should be prepared to lose every penny you put down. If you can’t afford, or stomach, that sort of loss, don’t play.”
• “‘How is GameStop’s actual business doing?’ Not well. GameStop started the year at $18.84 a share. The company is in its second year of double-digit revenue declines, with its 5,000 brick-and-mortar stores struggling as videogames go digital and the pandemic continues. GameStop’s holiday sales for 2020 were down 3.1% year over year. That is why there were so many traders betting against the stock earlier this year, and it is why they are still doing it.”

Now back to that fun scenario. Hedge fund professionals do have tons of data, and massive amounts of money at hand. And the day traders have caught up to the point where they are all but equal. The Reddit, day trader types have fast computers, with vast amounts of data at hand. Unlike hedge funds, they can trade stock for free, and collectively have all the money they need. And through various Internet connections, they are well informed and very well coordinated . And the beating the day traders gave the hedge funds proves their power.  

Again, unlike hedge funds, day traders can manipulate and pump and dump all they want; it is legal because no collusion can be proven. Deeply wrong, but legal. Now, the Reddits are turning their money and ambitions to other stocks and markets, e.g., AMC stock and the silver market. Quick history lesson. In the late 70s, the Hunt brothers tried to corner the silver market so they could make massive amounts of money from having a monopoly: They went broke.

Today’s Key Point: Market manipulation, pump and dumps, chain letters and Ponzi Schemes are wrong–no matter who perpetrates them. And it is often the last one in, the little guy, who loses more than he can afford.

A parting thought. “It is not just little people on the long side here. There are huge players playing both sides of GameStop,” said Thomas Peterffy, chairman of Interactive Brokers Group Inc. Richard Mashaal and Brian Gonick at Senvest Investment, along with many other big players, made real money here. They aren’t Reddit day traders or Discord users; they are hedge-fund managers in New York. And when the stock surged from less than $10 a share to above $400 and the dust had settled, they were sitting on a profit of nearly $700 million, one of the great fortunes of the January market mania.

Tell me what you believe. I and many others want to know. 

As always, whatever you do, do it in love. Without love, anything we do is empty. 1 Corinthians 16:14

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Will Luden, coming to you from 7,200’ in Colorado Springs.