Weed stocks were on a high — then they got crushed

If you’re invested in any one of the major weed stocks listed on the Toronto Stock Exchange, the past few months must have been utterly nerve-wracking. After a sharp bull run in the in the months leading up to 2018, shares of some of the biggest licensed producers in Canada plunged in the second half of January and into early February, only recovering slightly this past week.

Between Friday, January 26 and Monday, February 5, shares of Canopy Growth Corporation, the world’s biggest cannabis producer, lost just over 30 percent of its market value. Aphria Inc., and Aurora Cannabis, two other prominent licensed producers saw their stock price erode in that time frame as well, with Aphria also losing about 30 percent of its value.

Sure, there was a mini flash crash of sorts on all major North American markets in early February and pot stocks were caught up in that decline. But in the 10 days leading up to February 5, the TSX declined by 5.5 percent, whereas pot stocks saw a drop six times that number. So what exactly happened?

Fall 2017: The Bull Run

We have to put these numbers in context, Aaron Salz, founder of Toronto-based consulting firm Stoic Advisory told VICE Money. “Prior to the mini flash crash, the S&P 500 was up 12 percent in three months, but the cannabis sector as whole was up 180 percent over that same three month period. So weed stocks had a bull run, and then there was profit taking, which explains the drop.”

That bull run Salz refers to, began in the fall of 2017, and was catalyzed by two main factors — the surge in provinces finalizing their distribution models and locking in supplier agreements with licensed producers, and the mammoth announcement by alcohol giant Constellation Brands that it was acquiring a 9.9 percent stake in Canopy Growth, which kicked off a flurry of dealmaking activity.

“Prices had increased by 109 percent during that short period of time, and the overall market cap for just the publicly-traded stocks was $26 billion,” Alan Brochstein, founder of New Cannabis Ventures told VICE Money. “A similar surge had happened before in April 2017, and that ended with a correction.”

Weed stocks are the kind of equity that analysts frequently associate with the term “momentum investing” — when the stock price accelerates, the investor, or trader will take either a long or short position in the stock, and hope that its momentum will continue in either one direction or the other. Because of how catalyst-driven momentum stocks are, they also tend to fluctuate according to the news cycle.

“We had a flurry of companies raising money in the end of 2017, and early 2018 and things got really busy very quickly. I think that just exhausted the market to some degree, and people were ready to take in their profits,” says Salz. In a sector where dealmaking is becoming the new norm, he says, expect to see lots of volatility in the months ahead, at least until legalization actually takes place.

Brochstein agrees: “I think the Canadian market got way ahead of itself with all those mergers and acquisitions. The momentum was building, and a correction was due to happen."

The ETF Factor

When Horizons ETFs launched the first ever marijuana ETF back in April 2017 — the Horizons Marijuana Life Sciences Index ETF (HMMJ) — there was a sharp surge in pot stocks. People who weren’t exactly sure what specific cannabis company to buy into, could now just invest in the sector as a whole.

In December, a new pot ETF entered the market — ETFMG Alternative Harvest ETF (MJX) — this time trading on the NYSE Arca, an exchange that focuses on trading ETFs. Again pot stocks soared. Brochstein believe that the launch of ETFs are in part, moving weed stocks, or “distorting the market” as he calls it, because they result in a sudden, increased demand for Canadian licensed producers that these ETFs invest in.

Using the publicly-listed cannabis LP Cronos Group as an example, Brochstein wrote, back in December: “Each dollar invested into MJX results in over 8 cents into Cronos Group, which impacts it more due to its lower market cap.” In other words, these marijuana ETFs, are to some extent, inflating the valuation (and stock price) of a company.

For Greg Taylor however, portfolio manager at Redwood Asset Management that just launched yet another marijuana ETF early February, the volatility of the weed sector is in fact a reason to invest in an actively-managed weed ETF. “It’ll give you a basket of exposure and mitigate your risk factors,” he told VICE Money.

Speculative pressures

The notion that weed stocks are in bubble territory has been frequently disputed by market bulls like Salz, who believe that public markets, because of how their massive valuations, have fooled the mainstream investor into thinking that weed is a global hyper growth industry. In actual fact, says Salz, there’s still a scarcity of investment opportunities, especially on the institutional side. “Because of that scarcity, capital is flooding into just a handful of companies which I think is clouding the view of the sector as a whole.”

But analysts like Brochstein take a different view — he believes in the sector in the long-run while at the same time calling it a speculative market. “I’d associate it somewhat with bitcoin, Tesla, the 3-D printing craze. There is a lot of psychology that goes into how these markets operate. Stock traders have a fear of missing out. So dumb money comes in, and pushes up the stock, and that’s what happened in Canada — unrealistic valuations in weed stocks.”

For Brochstein, the value of the stock of a weed company is much less important than understanding the potential growth of the sector in the long run. There are currently 28 publicly-traded companies and 89 Health Canada licenses to cultivate weed; publicly-traded companies own 39 of these licenses, and the rest are scattered amongst smaller private companies.

“I don’t think a lot of these companies are going to exist in around five to 10 years. This is why I wouldn’t get too hung up on how much the company is valued on the stock market right now,” Brochstein says.

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