Canadian Short Rotation: Out of Cannabis into Bellwethers


As Americans, we have a tendency to view our country as the center of the modern financial world. While this is still true in most circumstances, it’s not always the case. For instance, the legalized cannabis industry in the U.S. is a step behind our neighbor to the north. Canada will fully legalize cannabis on July 1 2018, and marijuana is already legal for medical patients. Canada’s progressive stance on cannabis has laid the groundwork for a thriving industry.

A natural consequence is that the first cohort of cannabis companies to attain billion dollar valuations are all listed on the Toronto Stock Exchange (“TSX”). Aphria (APH.T), Canopy Growth (WEED.T), Aurora (ACB.T) are just a few that have gained unicorn status, based largely on the prospect of future growth. The investment thesis behind these stocks is that whomever is able to gain market share, could become the Anheuser-Busch (BUD) of cannabis.

U.S. cannabis stocks haven’t fared quite as well as their Canadian counterparts, predominantly because cannabis is still federally illegal. That’s not to say that U.S. cannabis companies haven’t experienced tremendous growth, because they have. Recreational cannabis alone is a $7 billion industry, projected to grow to $22 billion by 2021.

But even burgeoning markets like cannabis can get a little ahead of themselves, and when that happens, short sellers often take notice. Case in point, after a significant run in stock prices, may TSX listed cannabis companies saw a steady increase in short activity.

The chart below shows trading volume and corresponding short volume in Canopy Growth. Canopy’s chart is fairly indicative of other TSX listed cannabis stocks during the period.

Below is a second chart that shows the most heavily shorted companies on the TSX in the month of February, and a disproportionate number of them are cannabis stocks.

In early 2018, many cannabis stocks trading on the Toronto Exchange hit all time highs, before coming off those highs in recent weeks. The pullback was significant enough that many short-sellers covered their positions and rotated into new sectors. Looking at the most recent data, investors have set their sights on industry stalwarts like banks, infrastructure and insurance companies.

While Canopy and Aurora still made the list of most heavily shorted stocks, the rotation into names that are typically considered to be economic bellwethers (including an S&P ETF), is somewhat concerning.

Perhaps this is nothing more than a reaction to a potential trade war with America, but the impetus is somewhat uncertain. What is clear however, is that short sellers are betting heavily against companies that tend to trade in lockstep with the overall health of the Canadian economy.

Sylva was not compensated by any of the companies mentioned in this article.

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