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How Long Will Bearish Momentum Continue In Cannabis Stocks?

Cannabis stocks have been hit hard in the last 2 months. This is an ultra-volatile market. It should be concerned ‘normal’ that this sector did rise a multi-fold in the first 4 months of this year, followed by a 50% decline in the subsequent 2 months. That’s in a nutshell the cannabis stock market sector in the first part of 2019. What’s in store for the 2nd part of 2019? And to which extent will our bullish stock environment as outlined in What May The 2nd Part Of 2019 Bring be supportive for cannabis stocks? Also, do we expect this hybrid market to continue, the one we observed in Cannabis Market Breaks Down As High Beta Conditions Improve? Based on our investing methodology (in particular intermarket capital flows) and basic chart analysis we get a good sense of the cannabis stock market, and pointers on the current shape and potential deterioration vs improvement.

Creating an overview of a stock market segment is not an easy thing to do. Essentially, it requires an in-depth market research. We can’t go that far, we have to work with high level data.

This article features 3 crucial data points which help us understand the state of the cannabis stock market segment:

  1. Capital flows out of the cannabis stock market segment as well as capital inflows into gold miners (interestingly, there might be a correlation between both, as in outflow from cannabis flowing into gold miners).
  2. Chart patterns across 10 leading cannabis stocks, and key take-aways.
  3. Appetite from institutional investors to for exposure in this segment.

Capital flows outside cannabis stocks

One important disclaimer for this section: this is no exact science. What we are going to share in this section is a ‘back of the enveloppe’ calculation in the last 2 months which should provide some orders of magnitude of two phenomenons:

  1. Capital flows outside of public cannabis stocks;
  2. Capital inflows into the gold and silver sector.

We believe this is a relevant metric to look at because of intermarket dynamics which says to capital flows from one market to another market in search for gains.

If we do this ‘back of the enveloppe’ calculation for 7 Canadian cannabis stocks with a market cap of +$1B we see selling pressure in the last 2 months sent some $7B out of these 7 stocks.

Again, this is not meant to be a perfect calculation, nor a complete for the whole sector. We want to get a sense of orders of magnitude here.

We take the last 2 months because that’s when cannabis stocks have been correcting strongly!

Capital flows into precious metals and miners

If we compare this with the hottest sector in the same 2 month period (gold, silver and precious metals stocks) what we do see?

Based on reliable data points we see this picture:

  • All gold ETF’s combined saw an inflow of some $6.2B + all silver ETF’s combined saw an inflow of some $0.8B.
  • When it comes to precious metals stocks we saw an inflow of approx $48B into GDX, an inflow of $27B into GDXJ, and top gold miners Royal Gold saw an inflow of $8B and Newmont Goldcorp $12B.

The gold and silver space saw in the last 2 months an inflow of much more than $100B (we only looked at 2 stocks while there are plenty of large cap and mid cap precious metals stocks which we did not consider).

As an illustration we add the gold ETFs capital flows from the last 10 years (source Goldchartsrus.com)

gold inflows july 2019

Capital has been flowing from cannabis stocks into the precious metals space

What’s the point of this exercise?

It is meant to indicate that the cannabis space is pretty small. It is extremely small compared to the inflows that the precious metals space saw in the last 2 months.

Both markets are ultra volatile, and probably attract a similar investor profile.

Is there any coincidence in the cannabis space selling off at the same time capital flows into the precious metals space of an order of magnitude at a minimum 15x larger?

Because of intermarket dynamics it is very likely that cannabis investors went massively into precious metals stocks.

So the question becomes when will this outflow stop?

We believe we want to look at the charts to get a sense of how far vs close we are from key support levels.

Chart patterns across 10 leading cannabis stocks

We look at 10 cannabis stocks and what their chart patterns and chart trends look like.

  • WEED.TO: Its correction stopped exactly at the January 2018 top, some 30% above the January 2019 lows.
  • OGI.V: Its correction stopped exactly at the September 2018 highs.
  • ACB.TO: Its correction stopped at the 50% retracement level from the 2018 monster rally, now halfway in a sideways range in the last 18 months.
  • HEXO.TO: Its correction stopped halfway the trading range over the last 12 months.
  • EMH.V: Its correction stopped exactly at the bottom of January 2019, which is exactly the breakout point of October 2018 (during the monster rally). This is slightly below the bottom of summer 2018.
  • MNFF: This stock trades for only 12 months and trades at the lowest price since.
  • TCNNF: This stock trades for less than 12 months and trades halfway its range since.
  • CURLF: This stock trades for less than 12 months and trades halfway its range since.
  • ACRGF: This stock trades for less than 9 months and makes a double bottom since its previous lows (Dec 2018).
  • FIRE.V: This stock trades in the lower area of its 12 month trading range.

The conclusion is pretty simple. The recent correction was pretty painful for cannabis investors but the charts are not concerning at this point in time. We see lots of indications that the worst is over now, very often do we see the start of what has the looking of a rounded bottom.

Most charts show a healthy correction, and presumably the start of a stabilization around attractive areas on the individual chart patterns.

However, there is no consistent view, so our previous observation of a hybrid market is still valid.

Appetite from institutional investors for exposure in this segment

One more data point that we believe is important to consider is appetite from institutional investors to invest in this sector.

We found a very interesting finding from New Cannabis Ventures (see their homepage) which is a very reliable source. This is what they wrote today:

Almost $2 billion worth of capital is waiting to be deployed into the cannabis sector, and the financial media has been slow to notice this new development. This potential capital isn’t being raised by established private or public entities but instead by special purpose acquisition companies. Two sponsors of previous deals have returned to the market, Mercer Park and Canaccord Genuity, and several others have joined them.

The continue:

SPACs in general have very specific rules that offer IPO investors protection, like the ability to redeem their investment as we saw with the MTech (now Akerna) deal. In Canada, the only exchange that currently lists SPACs is the NEO, which has a spotty record of liquidity thus far. The good news, though, is that these SPACs can invest in either direct or ancillary cannabis companies operating in the United States. In the U.S, we have seen one NASDAQ SPAC close its acquisition when Akerna bought MJ Freeway, and, for now, these SPACs will be limited from buying American cannabis operators but able to invest in American ancillary companies, CBD companies and non-U.S. companies operating under a federally legal program.

What this one data point learns is there is sufficient institutional interest in this sector. The figure we see $2B is convincing enough, even though this is ‘just’ one data point, that it is relevant enough. Remember, as said earlier, the outflow for 7 publicly trading cannabis stocks in the last 2 months is some $7B (this $2B investment is significant).

Conclusion: cannabis stocks close to flashing a buy signal

We are not there yet, but if cannabis stocks stabilize at current levels, implying all weak hands already went into precious metals, we can reasonably believe that current levels in the cannabis sector are long term bottoms.

What do we want to see?

  1. Large cap and mid cap cannabis stocks lead the way higher (stop falling at a minimum).
  2. Chart support respected for most of the cannabis stocks.

The general broad market trend is favorable for high beta stocks, also for cannabis stocks. So once the profit potential in gold and silver miners dries up, we believe cannabis stocks are a top favorite to start booming again. This may happen in the 2nd part of 2019.

One note: as we tipped EMH.V as a top cannabis stock, among 3 other names, but it’s the only one that did not perform well, we will publish a separate article on EMH.V within the next 24 hours.

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