TSX Venture Investing

The End of the Marijuana Stock Bull Market

Marijuana Stocks

Marijuana stocks are on fire once again.

In anticipation that Trudeau’s Liberals will legalize recreational use of marijuana this spring, the sector is witnessing a surge of capital even the weed stock mania of two and a half years ago couldn’t touch; and that’s saying a lot…

The rush to marijuana names on the TSX Venture and CSE over the last three months is bordering on speculative insanity. Valuations suggest the market is anticipating nothing but blue sky ahead…

The marijuana market is getting so frothy that public companies in the space with even the slightest potential of acquiring legitimate assets are now being cold called by funds and brokers soliciting funding. It’s typically the other way around…

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Word on Howe Street is that some well-known institutions in Canada are trying to corner the market by taking large ownership positions for clients in emerging marijuana opportunities. There are even rumours that high net-worth Chinese investors and venture capitalists are looking to acquire big stakes in publicly traded marijuana-related companies. This rumoured ‘smart money’ interest is something we didn’t see in the 2014 marijuana stock hysteria (read our report on that period here). And that’s what makes the 2016 boom so spectacular.

To demonstrate just how wild valuations may be getting, we selected ten marijuana-related stocks on the Venture and CSE… just look at the similarity of their stock charts over the past 90 days:

marijuana stock chart

marijuana stock chart

marijuana stock chart

marijuana stock chart

marijuana stock chart

marijuana stock chart

marijuana stock chart

marii8

marijuana stock chart

marijuana stock chart

When you see an entire suite of names in the same sector move up in unison, like this, you know there’s a lot more going on behind the scenes than just press releases… big money has moved in, and the news cycle is bullishly in favour of this sector.

Adding fuel to the parabolic rise in the industry is that five states in the U.S. — California, Arizona, Massachusetts, Maine and Nevada — will vote on whether to legalize marijuana for recreational use in less than three weeks. And with a record 60% of Americans supporting recreational marijuana legalization, according to a recent Gallup poll, it is anticipated that at least four of the five states will pass the bill. There is a groundswell of public support for legalization. Bear in mind, it was only in the 90s when just a quarter of Americans supported such a measure.

What’s more, California alone has a bigger economy, and more people, than Canada. In fact, California is the sixth largest economy in the world… that alone is enticing speculators to jump into marijuana stocks, which are already at highly bullish levels.

With all the excitement, we’re here to sound the warning bells… we believe there is a strong possibility that momentum within the marijuana sector will fizzle out by Q1 2017. Although the industry has massive long-term upside, current valuations for most names within the space are vulnerably high.

 

Hillary’s Effect on Marijuana Stock Bull Market

If you trust the polls, Hillary Clinton is running away with the presidential race. If she is the next President, many industries will be impacted, some positively, others negatively.

We believe Hillary Clinton will be a hindrance to growth in the marijuana space, at least over the short to medium-term…

 

Good News Can’t Last for Marijuana Stocks

Never discount the value and impact of the news cycle on speculative stocks. We contend that industry headlines in the mainstream media dictate the direction of micro caps more so than fundamental development. That stated, valuations and hype around the marijuana sector are baking in continued positive news. This is dangerous for small cap investors, particularly if you’re looking to trade names within the space.

With marijuana hype and valuations rising at a ridiculous clip, the slightest negative shift in sentiment could send the sector tail spinning 20% overnight. If legislation is Hillary Clintonstalled, or the U.S. government under Clinton takes the same stance as the Obama Administration on marijuana (which is basically that there are more important matters to deal with), it will remain a fragmented sector with regionalized growth; and it will be plagued with logistical and legal challenges impeding marijuana companies from interstate commerce. We believe Clinton will delay the end of marijuana prohibition, thus resulting in the sector losing steam if she takes office in 2017. Here’s why:

 

Clinton’s Record as a Defender of Pot Prohibition

By now, you’ve likely heard about the Wikileaks data dumps. Every day a new scandal emerges thanks to Julian Assange’s team. And all the data dumps appear to tarnish Clinton’s reputation and trustworthiness.

Wikileaks exposes Hillary Clinton
Wikileaks has transformed the political landscape in the U.S. this year with its ‘data dumps’ in recent weeks.

 

If you’ve been following the Wikileaks story, then you’ve likely heard about Clinton’s speech to bankers where she was quoted as saying, “you need a public and private position” on some policy issues… this created a PR nightmare for her and was pounced on by Trump.

But what wasn’t covered by the mainstream media, and is likely more relevant to readers of this letter as many of you likely own a marijuana stock or two, were her private comments to bankers and the Xerox CEO about pot in 2014…

Wikileaks reported that in a paid speech to Wall Street bankers, one of the many speech transcripts Bernie Sanders and Republicans demanded Clinton reveal to the public, Hillary allegedly stated she would stand against recreational marijuana legalization “in all senses of the word”

Here is an excerpt from dialogue of that speech documented by reason.com:

“But in an email circulated among senior Clinton campaign staffers concerned about the content of Clinton’s paid corporate speeches and appearances-which includes an 80-page attachment detailing “a lot of policy positions that we should give an extra scrub”-a brief portion of Clinton’s Q & A with Xerox CEO Ursula Burns in 2014 shows Clinton’s staunch opposition to any form of marijuana legalization:

URSULA BURNS: So long means thumbs up, short means thumbs down; or long means I support, short means I don’t. I’m going to start with – I’m going to give you about ten long-shorts.

SECRETARY CLINTON: Even if you could make money on a short, you can’t answer short.

URSULA BURNS: You can answer short, but you got to be careful about letting anybody else know that. They will bet against you. So legalization of pot?

SECRETARY CLINTON: Short in all senses of the word. (emphasis added)”

 

Wikileaks also reported, via data from the email hack of Hillary’s campaign chairman John Podesta, that Clinton believes legalizing marijuana is politically untenable.

One of Clinton’s likely reasons for opposition to pot:

Recreational marijuana purchases are largely cash-based…

Cash-dominant industries don’t help the big bankers (her largest donors); and cash transactions make marijuana sales incredibly hard to audit and tax efficiently.

Clinton will support medical marijuana (at least publicly), but not recreational use… that’s because medical marijuana can be monitored by the banks and controlled by government. One gets a prescription, pays a pharmacist or designated distributor, perhaps is reimbursed by health insurance, and uses the plant for treatment. That transaction is tracked, the revenue can be taxed, and the purchase is enabled by the banking system (with fees). Everyone in the Clinton camp wins.

Bloomberg’s David Freelander reported,

“Plus, they want access to the banking system. For now, even legal marijuana businesses remain all-cash, since many banks won’t accept their money for fear of violating federal laws, and sellers and grow operations are unable to deduct their businesses expenses like other entities.”

 

Setting up the framework to control the recreational side of the industry, which has been a painstaking process for Trudeau’s cabinet (scheduled for Spring 2017 – 18 months Justin Trudeauafter taking office), is the key for governments to capitalize on this potential revenue boon…

Will it take Clinton a similar amount of time to set up a comparable framework for legalizing marijuana in America? Likely much longer – provided she even wants to do it. Clinton would have many more complexities, and less power than Trudeau in her country than he in is, to deal with. If she wins, marijuana won’t be a first-term issue. And until the federal government in the U.S. legalizes recreational use, the industry won’t expand to a level the market may already be pricing in.

 

Weed Market Present Roadblocks for Clinton

Hillary Clinton has major conflicts with legalizing marijuana at the federal level.

You see, Big Pharma is perhaps the largest opponent of legalization of marijuana. Simply put, pot is competition to drug makers.

Reuters reported, “Hillary Clinton has taken more money from employees of America’s 15 biggest pharmaceuticals companies than all of the Republicans who attempted a run for the White House this year combined, according to campaign finance disclosures.”

The liquor lobby is also one of the major opponents of legalizing marijuana, particularly for recreational use. And it’s for the same reason as Big Pharma: competition and fear of market share loss.

Big liquor has been a huge donor to the DNC and its candidates, including former chairperson and close Clinton ally Debbie Wasserman Schultz who resigned in disgrace recently. Not surprisingly, Debbie Wasserman SchultzSchultz has been outspokenly against legalization of marijuana despite an approximate 65% of registered Democrats supporting it. When speaking about marijuana, she told The New York Times Magazine that, “I just don’t think we should legalize more mind-altering substances if we want to make it less likely that people travel down the path toward using drugs.”

Naturally, legalization of marijuana cuts into liquor profits. In fact, it was reported by Forbes that tax revenue generated from marijuana in Colorado last year outpaced that of liquor sales.

Then there’s the private prison lobby. That’s right, America has a private prison lobby…

Before you write this off as a conspiracy theory, understand that the prison lobby is extremely powerful in America because the country has 130+ private prisons. And private prisons have shareholders, boards of directors and are profit driven – a uniquely American incarceration culture.

The Intercept reported:

“Corrections Corporation was founded in 1983 by the former chair of the Tennessee Republican Party, who leveraged his political ties to win a number of government contracts to operate prison and immigrant detention facilities. The company has used its political influence to shape its rapid growth. Corrections Corporation used a third party advocacy group, the American Legislative Exchange Council, to lobby for “three strikes” and “truth-in-sentencing” laws that fueled the growth of prison populations, as well as for privatization laws that handed control of federal and state prison facilities to private operators. In recent years, the company’s lobbyists played a role in promoting state laws that encourage local police to arrest undocumented immigrants.”

The Intercept also reported:

“Hillary Clinton has a complicated history with incarceration. As first lady, she championed efforts to get tough on crime. “We need more police, we need more and tougher prison sentences for repeat offenders,” Clinton said in 1994. “The ‘three strikes and you’re out’ for violent offenders has to be part of the plan. We need more prisons to keep violent offenders for as long as it takes to keep them off the streets,” she added.”

Despite Clinton’s campaign rhetoric about ending private prisons (we are skeptical of what she says given her “private” and “public” position comment revealed by Wikileaks), the Intercept and Daily Caller reported that some of Hillary’s best bundlers lobby for private prisons in Washington…

Private Prisons in the U.S.
There are over 130 private prisons in the U.S.

 

Key fact: the private federal prison population more than doubled between 2000 and 2010, according to a report by the Justice Policy Institute.

ACLU.org sources a 10k filing from one of the largest publicly traded private prison firms in the country. In that report the company states, in respect to business risks:

“The demand for our facilities and services could be adversely affected by the relaxation of enforcement efforts, leniency in conviction or parole standards and sentencing practices or through the decriminalization of certain activities that are currently proscribed by criminal laws.”

 

Before it was a popular political issue, and during the 2008 campaign when she ran against Obama, Hillary was openly against recreational marijuana use and hesitant toward medical marijuana; now, she says she’s open to it and wants to remove it from the ‘Schedule 1’ list so researchers can study its legitimacy in medicine. However, we don’t think she has the political will to push for recreational legalization. It just isn’t that important for her given the strain it would put on relationships with some of her biggest donors. And therein lies the short-term trouble ahead for the marijuana industry if Clinton is elected. We don’t see it being any better if Trump is elected either, although he has different motives.

 

Repeat of the Last Marijuana Bull Market?

We’re not bearish on the long-term upside potential for the marijuana sector – not at all. And we do believe it will be legalized in Canada for recreational use next spring. But Canada’s market really isn’t that big, frankly. The U.S. is the Holy Grail for any industry. For recreational marijuana acceptance to be law of that land it will take years, and the trifecta of control (Executive, Senate and House), for any administration to set up the necessary framework to see it through. After all, that was the only reason Obamacare passed – and recreational marijuana use is almost as partisan of an issue right now.

Anyone who ignores history does so at his own peril. Although a more boisterous bull market than 2014, we see the 2016 marijuana stock bull market playing out in a similar fashion. In 2014, valuations of the more established names took off first to astronomical levels, then more speculative names went parabolic (which is the stage we are currently at); and then the market realized the pie just wasn’t big enough at that time for all to succeed, resulting in a marijuana stock hibernation and the news cycle drying up. We see the sector temporarily peaking within 60 days of November 8th, after California approves the plant for recreational use.

Investors will soon realize that either a Clinton or Trump Administration aren’t focused on legalizing recreational marijuana at the federal level.

All the best with your investments,

 

PINNACLEDIGEST.COM

 

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