Cannabis stocks have been getting clobbered of late, and as negative momentum picks up, losses may exceed the threshold of pain for even the most seasoned of traders. Past corrections to pot stocks have been vicious and unforgiving, but with Canopy Growth (TSX:WEED)(NYSE:CGC) stock now down over 65% from its high, it appears that the curtains are finally closing on the cannabis sector.
So, is this the final pop of the cannabis bubble — or is this sell-off exaggerated beyond proportion?
A dire warning
Just over a year ago, I gave my dire prediction for cannabis stocks after legalization day, urging investors to avoid them like the plague as they hovered near their all-time highs, citing a “sell the news scenario” and the potential for tremendous disappointment due to the continued proliferation of the black market.
Back in February 2018, I warned investors that “the black market may become a major issue,” citing high “cost per gram of legal marijuana” as the primary reason why the black market had the potential to cause a legal weed glut if the cost spread between legal and illegal weed was too large.
While everybody was talking about the cannabis supply shortage that would come with year one of legal marijuana, few noted the possibility that the black market would fulfill the rising demand in the post-legalization era.
It’s tough to quantify the amount of weed being sold in the black market, which is a significant reason why pot investors got burned if they bought right before pot was officially legalized. Many Canadians are legally growing their own plants at home (and likely far too much for a single family to smoke in a year after every harvest).
A disturbing trend
Just a year into nationwide cannabis legalization and the cost spread has grown to the largest it’s ever been. In a recent crowdsourced data compilation conducted by StatsCan, the cost per gram of legal marijuana is almost twice as much as that of illegal marijuana ($10.23 legal vs. $5.59 illegal) as of Q3 2019.
Compared to Q4 2018, the cost per gram of legal weed has actually increased by nearly $0.50, while illegal weed costs decreased by almost $0.80.
Uptrending legal weed costs and down-trending illegal weed costs are a formula for a legal weed glut, and with little to no discussion about the situation in electoral debates, it appears that the spread (and legal weed glut) could get worse before it gets better.
A world of pain up ahead?
The widening cost gap between legal and illegal weed could mean more pain ahead for pot investors. To make the whole situation even uglier, Canopy Growth stock has a double-top technical pattern; should it come to fruition, Canopy’s price target lies in the single digits, at around $5, implying substantial losses for those who attempt to catch the falling knife.
Could Canopy Growth fall to $5?
The technicals seem to indicate such, but that doesn’t necessarily mean that the stock ought to be worth that amount. Personally, I think the sell-off is overextended at this point, given Canopy’s competitive advantages and the long-term growth trajectory.
With no catalysts to stop the bleeding, however, I suspect that Canopy will continue to be the baby that’s thrown out with the bathwater, as investors collectively throw in the towel on pot stocks overall.
If you’re looking to buy the dip at Canopy, make sure to average down your cost basis because the technicals are dire, and at least for now, the fundamentals aren’t going to matter.
Stay hungry. Stay Foolish.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.
Fool contributor Joey Frenette has no position in any of the stocks mentioned.