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Warning: This Story From Colorado Could Mean Bad News for Marijuana Stocks

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Marijuana stocks are once again on the wane. After months of solid returns, marijuana leaders like Canopy Growth Corp (TSX:WEED)(NYSE:CGC) began sliding in March, with some down as much as 11% in a month. Although marijuana is a highly volatile sector, the present bearish trend comes at a time when most TSX stocks are doing well, so it may reflect more fundamental problems than those seen in the late-2018 crash.

It’s not exactly clear why investors are selling marijuana stocks. The weed market is still growing like lightning, and Ontario just legalized in-store cannabis sales. However, it’s possible that a delayed reaction to post-legalization earnings could be contributing to negative sentiment. Although investors were wowed by the three figure growth that marijuana producers posted for 2018, they may have taken a while to realize the structural problems the sector faces. One of those problems will be familiar to marijuana buyers in the U.S. State of Colorado–and while it is definitely good news for them, it could be bad news for investors.

Why the price of pot went down after legalization hit in Colorado

The State of Colorado voted to legalize marijuana in Colorado in 2012. The law took effect in 2014, and since then–surprise!–the price of pot has gone down. According to a 2018 story in The Coloradoan, the price for a pound of pot dropped by $400 to $846 in 2018. In 2015, it had been as high as $2050. The article went on to explain that the retail marijuana market was rapidly growing, with lots of new producers adding supply to the market. Marijuana vendors attributed the falling price of pot to this increase in supply, saying that the market was becoming more and more competitive.

A perfectly competitive market?

Marijuana is essentially a commodity. Although weed smokers may have a preference for certain strains, there’s not a huge amount of brand loyalty in the market overall. This being the case, the marijuana industry will over time tend to become highly competitive. As more and more suppliers flood the market with weed, they’ll be downward pressure on prices and prices will fall. It looks like this is happening in Canada, just as it happened in Colorado.

In its most recent quarter, Aphria Inc (TSX:APHA)(NYSE:APHA) reported that its average selling price per gram decreased from $8.99 to $7.51. While cannabis producers could counteract falling prices with cheaper production techniques, there’s a serious risk of declines this steep eating into their margins. And at any rate, the cost of producing cannabis is actually rising.

What this means for investors

A “perfectly competitive market” is far from a “perfect” thing for investors. In such markets, prices tend to fall, taking margins along with them. Of course, with dozens of international markets and U.S. states to break into, marijuana producers have plenty of room to grow their sales volume. That said, most of these companies are already losing money on operations–which isn’t a situation you want to be in while selling prices are tanking.

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Fool contributor Andrew Button has no position in any of the stocks mentioned.

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