The Cannabis Industry and the Inevitable Pendulum Shift

11/22/2019 by: Bill Cox

“The market is a pendulum that forever swings between unsustainable optimism (which makes stocks too expensive) and unjustified pessimism (which makes them too cheap). The Intelligent Investor is a realist who sells to optimists and buys from pessimists.”

― Jason Zweig, The Intelligent Investor

There is an old market adage, “Don’t call the bottom, watch for it.” Even this has likely been a painful endeavor for many cannabis industry investors. Sentiment for the cannabis industry is at an all-time low. This has been driven by a long downtrend caused by a myriad of issues facing the industry. From oversupply in Canada to slow legislative movement in the US, the cannabis industry simply had no news to cause the hype and hysteria which ensued back in 2017-2018.

However, this is beginning to change. Just as cannabis stocks (and their respective valuations) went well above and beyond anything that resembled reality, pessimism has now too gotten out of hand. A slew of cannabis industry earnings over the last couple weeks sent already reeling pot stocks down hard.

Virtually every single cannabis stock is down between 50 – 80 percent off the highs from earlier in the year. Fortunes have been made by short sellers, but their luck may soon be coming to an end.

Currently, short bets are making up an extraordinary percentage of the float on many top name cannabis companies. A recent Market Watch article outlines some of the large short positions across the industry:

“Short positions in Tilray Inc. TLRY, +5.31%, which is based in Toronto but listed only on Nasdaq, have increased to 38% of the float on Wednesday from about 22% on Jan. 1, according to S3 data.
For market leader Canopy Growth Corp. CGC, +12.47%  , WEED, +12.69%  which trades on the Toronto Stock Exchange and the New York Stock Exchange, short interest has increased to an aggregate 25% from about 14% in January.
At Aurora Cannabis ACB, +6.42%  , ACB, +6.79%  the most widely held cannabis stock which also trades on the TSX and NYSE, short positions now account
 for an aggregate 19% of the float versus 12% in January. At Aphria Inc. APHA, +5.19%  , APHA, +5.81%  also traded on TSX and NYSE, shorts account for 16% of the float compared with 15% in January.
At Hexo Corp. HEXO, +6.33%  , HEXO, +5.12%  which is dual listed on the TSX and NYSE, short positions account for 15% of the float compared with just 6% in January.
For Cronos Group Inc. CRON, +7.44%  , CRON, +7.65%  which trades on the TSX and on Nasdaq, short positions have grown to 26% of its float from 14%, while at Green Organic TGODF, +9.60% TGOD, +11.96%  which trades on the TSE and the U.S. over-the-counter market, short positions have climbed to 5% from 2%.”

Market Watch: Short sellers are increasing bets on cannabis stocks even after summer selloff
Published: Nov 10, 2019 11:46 a.m. ET

Millions of shares have been shorted, worth many millions more. The dirty little secret about the infamous short sellers is that they can be a blessing in disguise when they flip sentiment. This is because, in order to close their positions, they must BUY the stock!

A short squeeze occurs when a significant move higher forces a significant amount of shorts to “cover” (or buy) the stock in order to stop losses from a quickly rising stock. Any good news for the industry at these levels could easily trigger a monumental rally fueled by short covering. This would be followed by technical indicators shifting positive bringing in traders, possibly even former short sellers, back into the bullish sentiment. This can bring about a domino effect of shorts covering, and bulls regaining confidence.

There is clearly a lot of bad news baked into the cake here, so lets look at potential factors that may push the pendulum back in the right direction.

The Next Big Catalyst?

Cannabis legislation is finally back in the news. Even better, it’s for the US. The House Judiciary Committee approved the MORE Act, with a bipartisan vote 24-10 earlier this week. The Bill would decriminalize cannabis on the Federal level which would certainly be a monumental catalyst for the industry. One of my favorite recent headlines was an article published by Yahoo! Finance titled, “Marijuana stocks see their best day of the year amid pro-legalization moves.”

Regardless of the chances of passing through the Senate any time soon, cannabis stocks have been flying over the last few days. This is a very good sign investors are looking for reasons to own pot stocks.

Last Summer the House of Representatives passed the “Secure And Fair Enforcement Banking Act of 2019” or the “SAFE Banking Act of 2019”. This caused a bit of a stir within the industry but quickly faded. This is expected to make its way to the Senate in 2020.

According to Congress.gov, “The purpose of this Act is to increase public safety by ensuring access to financial services to cannabis-related legitimate businesses and service providers and reducing the amount of cash at such businesses.”

Indeed, little to no access to banking services has been a thorn in the side of the US cannabis industry since inception. Even in States where it is legal, companies must resort to paying employees and even taxes with bags full of cash. For larger operations, they are literally paying taxes with truck loads of cash.

This also causes issues with funding. Dilutive and toxic funding have been the norm in the US as simply getting a loan from a bank is not an option. This new legislation should open the door to more traditional types of funding for these companies, while eliminating costly logistics of moving large amounts of cash around rather than simply writing a check or accepting pay in the form of a debit or credit card.

Many had written off this legislation because Mitch McConnell vowed to disallow a vote in the Senate. However, more recently he seems to be slowly opening up to the industry and even visited cannabis facilities in California last month. According to MarijuanaMoment.net:

“McConnell, in turn, made no legislative commitments but noted that cannabis is a “complicated issue” and in particular made clear he understands the industry’s problems with banking access.
“He recognizes the issues that need to be resolved,” the attendee said.
That the luncheon and other meetings even took place is significant given the majority leader’s longstanding opposition to marijuana reform. While he’s been a champion of hemp legalization, he’s taken pains to distinguish the crop from what he’s described as its “illicit cousin,” marijuana..”

..” It’s likely that the House passage of the cannabis banking bill has put added pressure on McConnell to decide whether he’s willing to allow a vote on the modest reform measure in his chamber.”

Inside Mitch McConnell’s Private Lunch Meeting With The Marijuana Industry
Published October 11, 2019
By Tom Angell

If we get news in the coming weeks that McConnell will even allow the vote to take place in the Senate this could move the industry significantly higher. We will need to watch carefully for news of opposition or support, but this is absolutely a big deal. Surprise passage would surely send shorts scrambling to cover their positions and maybe even enter long positions as well. Again, this is very speculative but something to keep a close eye on.

Capitulation?

There have been several big moves down in recent months that looked as if they could be text book capitulation. The vaping crisis hit the news a few months back and many headlines were reading as though THC vaporizers were the problem. They were, except you had to dig deep into the article to realize it was only black market products that were causing harm. Stock prices seemed to react strongly to this flurry of negative headlines.

Then there was news of oversupply, followed soon after by earnings reports showing not just slowing growth, but falling sales. Virtually every cannabis stock got hit hard for several days straight, many fell 20% or more within a week or so.

Interestingly, most stocks have more than recovered their losses from last week after a 3 day mega rally. Many are actually up around 50% or more in the last few days. This has the potential to be that bottom we are supposed to watch for. There has certainly been an element of fear within the industry present for several months.

In my opinion, the industry is starting to look like a good buy at these levels. The lower it goes, the better the bet is for the future. Unless your argument is that the industry is not going to survive at all, it seems that there are some good buys emerging in the industry right now. It may need to cool down a bit after that monster 3-day rally, but you can almost feel a change in sentiment, which hopefully, is getting those short sellers a bit nervous and bringing the bulls back into the game.

By | 2019-11-22T07:20:47-05:00 November 22nd, 2019|Catalyst Trading, Current Events in the Cannabis Industry|0 Comments

About the Author:

I've traded stocks since 2001, and I've owned cannabis stocks since 2008. I discovered catalyst trading when ethanol replaced MTBE as a fuel additive in 2006. The cannabis industry has offered numerous trad-able catalyst events in the past, and will continue to do so into the future. Hemp and CBD legalization was just put through legislation by the House and Senate, and will soon be signed into law. These are the types of events catalyst trading attempts to capitalize on with maximum efficiency.

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