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Bigger Bubble: Cryptocurrencies or Cannabis?

As cryptocurrencies around the world continue to shatter records, and cannabis companies continue to prepare for high demand when cannabis officially becomes legalized in 2018, investors looking for quick gains have certainly cashed in of late by pouring their money into these two attractive sectors.

Positive sentiment and market hysteria aside, many analysts have noted that both the cryptocurrency segment and the cannabis industry are exhibiting concrete signs of overvaluation, creeping into bubble territory. With companies such as Aurora Cannabis Inc. (TSX:ACB) more than doubling over the past month (a 137% gain at the time of writing), and other major Canadian producers such as Canopy Growth Corp. (TSX:WEED) increasing 37%, and Aphria Inc. (TSX:APH) increasing 56% over the past month alone, it can be hard for investors to ignore such massive returns in such short amount of time.

Here are a few things to consider when assessing (1) if a bubble truly exists in these sectors, and (2) what the ceiling for growth expectations could be moving forward.

Bubble or no bubble?

Among the criteria for an investment to morph from being a prudent long-term capital growth strategy to pure speculation are the following:

A belief that prices will continue to rise based on positive sentiment and the feeling of others. The Nash equilibrium/game theory stuff you learned in economics 101 comes into play here — it is not necessarily the fundamentals of the company that matter, but what the general public believes others will do (buy or sell) with respect to a particular stock or sector.

A lack of understanding or a misunderstanding of the fundamental properties supporting said company or sector. Ask most investors in blockchain to describe accurately the exact components of the technology and how this technology works, and most of the time you’ll get a boiler-plate answer or no answer at all. Ask a marijuana investor the metrics used to justify said investment, size of the potential market, and forward valuation multiple ascribed to said company, and you may receive a blank stare.

Sophistication of investor base decreases over time. The idea that “smart money” (i.e., hedge funds and institutional investors) perhaps know more than the small retail investors looking to grow their TFSA or RRSP is a generally accepted principle. When institutional money steers clear of a sector (in general), and the vast majority of the rise of these cannabis ventures relies on continued “mom & pop” investment from investors and stoners alike, problems may be waiting around the corner.

Bottom line

With the recreational cannabis industry unlikely to be substantially larger than the current medical marijuana industry (those who will smoke weed heavily in 2018 likely already do), and large risks to the cryptocurrency sector stemming from a potential hack (which would be very bad news), flash crash, or a number of other serious potential threats on the horizon, the classification of “bubble” appears to me to be correct.

Who knows? Maybe Bitcoin will hit $100,000 at the end of 2018 and cannabis stocks will increase 500% next year across the board. I’m just not so sure.

Stay Foolish, my friends.

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Fool contributor Chris MacDonald has no position in any stocks mentioned in this article.

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