Canada’s law to legalize the recreational use of cannabis goes into effect Oct. 17, and prices of popular pot stocks will likely fluctuate and may include a sell-off, based on recent trends.
Major news surrounding cannabis stocks are often followed by sell-offs, says Jason Spatafora, co-founder of Marijuanastocks.com and a Miami-based trader.
When Bill C-45, the Cannabis Act, was signed into law by the Canadian Senate legalizing the recreational use of cannabis, the sell-off from traders started on June 6, he says. The law says that people who are 18 or 19 years of age and older, depending on the province or territory where they reside, will be able to grow, purchase and use cannabis.
“Usually these events are followed by sell-offs,” says Spatafora, who made the prediction publicly in a tweet on April 24. “If you look at the C-45 bill, it was followed by a few days of pullback.”
Oct. 17 is a critical date because many investors like to “sell the news,” says Michael Berger, founder of Technical420, a Miami-based company that conducts research on cannabis stocks.
“We think this trend will play out in the cannabis sector,” he says.
Investors who want to prep for the market’s reaction to the start of recreational use in Canada should consider selling a portion of their holdings of pot stocks to take advantage of the ensuing dips.
“You should always have cash on hand, but if you believe in the hypothesis that the market will pullback as I do, you can use the fear of missing out momentum as a means to get out a chunk of your position and reload on the dip,” he says. “This is if you believe history stays intact with January being the time for new highs.”
The trading season for cannabis stocks is cyclical and typically kicks off in the fall, but started earlier this year when Constellation Brands (ticker: STZ) purchased a 38 percent stake in Canadian cannabis company Canopy Growth ( CGC) in August for $4 billion. The sector’s seasonality means a surge in volume and liquidity from October through April while the highs tend to occur in January.
The date of when recreational use of marijuana is legal in Canada is noteworthy because smaller players who are not prepared or lack strong management will not likely survive the additional competition.
“It’s important because it is the beginning of the end for companies that were selling pipe dreams to investors,” Spatafora says. “If companies aren’t prepared here to fill a void within a global cannabis market, they are dead in the water. The result is that billions in capital leave these failed start ups and get funneled to better established companies.”
Investors who have not invested in pot stocks should wait until after the sell-off occurs.
“Traders can get in now, but investors should wait,” he says.
Canadian pot stocks such as Aurora Cannabis, Canopy Growth, The Organic Dutchman and ETFMG Alternative Harvest ETF ( MJ), a Summit, N.J.-based cannabis exchange-traded fund, will have long-term value, Spatafora says.
The Canadian cannabis industry is poised to perform well in the long run since demand will ramp up, Berger says. The passage of the federal law will encourage more investments in this budding sector.
Investors should focus on the companies positioned to capitalize on the recreational market such as Canopy Growth, Aurora Cannabis, Tilray ( TLRY) and Aphria, Berger says.
Some other smaller companies that are also good to add to a portfolio include the following: Ravenquest Biomed, due to its management team, growth prospects and valuation; LiveWell Canada, due to the continued execution, leverage to cannabidiol, relationship with Canopy Growth and valuation; and Emblem, due to the valuation, relationship with Aphria relationship and growth prospects, he says. Emblem is a medical cannabis producer, which recently purchased Natura Naturals, which operates a 662,000 square-foot licensed greenhouse, for CAD $25 million ($19 million).
Demand will exceed supply “in a good way,” Spatafora says. The impact on cannabis stocks will be short-term, depending on how it is “spun” by various companies and how investors react to it.
“It’s a new system they have to work out the early bugs in tracking it,” he says.
A report that was commissioned by Health Canada estimated that 926,000 kilograms of cannabis is needed for both medical and recreational use during the first legal year. The amount is higher than a report conducted by investment bank CIBC World Markets Corp., which predicted demand to reach 850,000 kilograms by 2020.
U.S. pot stocks are expected to also benefit from Canada’s legalization.
“A rising tide lifts all ships,” Spatafora says. “I think after Canada approves the recreational use of marijuana, investors will start focusing on U.S. companies and midterm election ballots for new states to come online.”
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