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Are Marijuana Stocks Heading for a Bitcoin-Type Crash?

All asset bubbles ultimately burst. And the investor psyche that creates these bubbles makes that happen.

A bubble is created when the price of an asset, such as stocks, ​gold, or real estate, rises quickly over a short period. These gains are usually not supported by economic fundamentals, like strong demand. You should have no doubts when you see investors bidding up the price beyond any real sustainable value.

Let’s take the example of Bitcoin, the largest cryptocurrency. Since reaching a record high of $19,511 on December 18, spurred by speculative frenzy and the introduction of regulated futures contracts in the U.S., Bitcoin rally is unraveling. Since mid-December, more than half its value has been wiped out amid regulatory actions worldwide.

Bitcoin is down 21% on the week. Rival coins Ripple, Etherium, and Litecoin tumbled at least 28%, as losses continued to spread across cryptocurrencies. Nouriel Roubini of Roubini Macro Associates told Bloomberg that Bitcoin is the “mother of all bubbles,” and its bubble is now bursting.

Marijuna stocks are following Bitcoin

What about Canadian marijuana stocks? Is this the next bubble to burst? I think the rally we saw in pot stocks has all the ingredients of being a bubble.

Marijuana stocks tumbled on February 2 amid widespread selling on concern that companies that had ballooning share prices are now overvalued.

According to Bloomberg data, the BI Canada Cannabis Index plunged as much as 19% — its biggest intraday drop on record — while the nation’s largest producers, including Canopy Growth Corp. (TSX:WEED) and Aurora Cannabis Inc. (TSX:ACB), plunged more than 40% from their January highs.

Investors flocked to these companies on speculations that once Canada opens its market for recreational use this summer, demand would soar, as the majority of illegal trade shifted to this market.

But we don’t know for sure what the size of the recreational pot market in Canada will be. The other big question mark is about the readiness of all the provinces and territories before the July 1st deadline to make the marijuana recreational use legal.

Marijuana companies that are eyeing the U.S. market for growth are also facing a very uncertain future, since Attorney General Jeff Sessions rescinded guidance from former president Barack Obama’s administration that allowed states to legalize marijuana with minimal federal interference.

Aphria Inc. (TSX:APH) last week announced that it was “considering strategic alternatives with respect to its U.S. cannabis-related interests, including the possible divestiture of its investments.” On Friday, the company confirmed that it was selling properties in Arizona.

The bottom line

Many analysts will call this dip a great buying opportunity, but I’ll reiterate my call to stay away from this sector until we have a clear understanding of the market potential and the regulatory environment post-legalization.

The risk of a great crash has increased drastically in this sector after the mad rush of last year that pushed the prices of top pot stocks to unsustainable levels. It’s better to pause and watch from the sidelines.

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Fool contributor Haris Anwar has no position in the companies mentioned.

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