Are these Pot Stocks About to Become the Next "GameStop"?

The raging bulls of Reddit are hunting for new short squeeze targets, and they're increasingly turning to the North American cannabis sector to find them.

In late January 2021, institutional investors were blindsided when the users of a subreddit known as r/wallstreetbets engineered a decentralized short squeeze of stock in American video game retailer, GameStop (NYSE:GME).

The short squeeze began when Reddit users on the investment-focused forum noticed that the daily trading volumes for the stock had greatly exceed the total number of publicly available shares.

This is totally on script for the anti-establishment movement on WSB [r/wallstreetbets] and Reddit. They are feeling their crowd-funding oats and are now aiming it at whatever social disruption they can cause. And no better historical symbol to amplify personal freedom and revolution than pot.Nexus Strategy founder and CEO, Tim Welsh

This led to the realization that a number of hedge funds and larger institutional investing concerns had short sold approximately 140% of GameStop's stock—which meant that many of the shorted shares had been re-lent and shorted again—leaving them vulnerable to a short squeeze.

As a result, thousands of retail investors began pouring their money into the stock—motivated in part by a sense of aggrievement towards the perceived role of institutional investing bodies during the 2008 GFC—which caused stock in GameStop to reach a pre-market value of over $500 (USD) per share at it's peak on 28 January.

This caused significant financial damage to many larger hedge funds and institutional investors—most notably Citron Research and Melvin Capital—which eventually led the trading app Robinhood and a number of other brokerages to restrict GameStop share purchases.

This effectively halted the squeeze, however the decision attracted considerable controversy due to accusations of market manipulation and anti-consumer practices from prominent businessmen such as Elon Musk, as well as condemnation from politicians on both sides of the aisle.

Scores of class action lawsuits were subsequently filed against Robinhood—although the beleaguered trading app has claimed that the decision to suspend trading was made by one its clearing houses, not the company itself—and a congressional hearing on the incident was called by US House Committee on Financial Services chair Maxine Waters.

And unfortunately for retail investors, stock in GameStop began to rapidly bleed value—as many began abandoned the short squeeze out of fear that their initial investment would be completely wiped out—bottoming out at $51.20 (USD) by close of trading 10 February.

"I don't think the retail punter story goes away overnight," Mirabaud sales trader Mark Taylor said.

"I am really only watching the price action and trying to make sense of it all."

To the Moon

Although many assumed the story would end there, the 8.8 million users on r/wallstreetbets have made it clear that they have no intention of stopping now.

They're determined to keep their punitive crusade against institutional investors moving forward, and after briefly becoming enamored with several other potential short squeeze targets—including AMC Entertaintment, Koss, and Blackberry—r/wallstreetbets subsequently turned its attention towards Silver.

"Everyone knows" that marijuana legalization is coming. Fewer people know exactly what that means. Anyone who's invested in cannabis for four or five years—long enough to witness first-hand the great Canadian cannabis boom-and-bust cycle of 2016-2018—knows full well how vulnerable their sector of the market is to exuberant hype cycles. Weed's had a GameStop moment before. All signs suggest that it could easily happen again.Forbes Correspondent, Chris Roberts

However, this campaign was also most likely doomed to fail, as although Silver possesses a "significant cyclical upside", its near-term outlook remains "nebulous", according to a statement from BCA Research.

"We have been positive the silver-to-gold ratio for the bulk of the year and it remains appealing. Historically, gold trades at 50 times the price of silver, but today, it exchanges at 70 times the price of its cousin," BCA explained in Australian Financial Review.  

This led the raging bulls of Reddit to begin searching for a new target, before eventually settling on the North American cannabis sector. Within days the r/wallstreetbets subreddit was flooded with posts that touted cannabis companies as the "the next GameStop", provoking a buying frenzy from retail investors.   

As a result, shares in a number of US and Canadian pot stocks—such as Tilray (NASDAQ:TLRY), Canopy Growth (NYSE:CGC), and Aurora Cannabis (TSE:ACB)—suddenly found themselves experiencing sharp boosts to their share price overnight.

At the same time, the Horizons Marijuana Life Science Index ETF (TSE:HMMJ)—which acts as a benchmark for the North American cannabis industry—reached a six month high on of 18.94 (CAD) on Wednesday this week.

"We believe the rally in Canadian names is mostly driven by retail investors, maybe fueled by Robinhood and Reddit, that's really piling into the Canadian cannabis names in particular," Cantor Fitzgerald analyst Pablo Zuanic said in an interview with CNBC.

"I'm not going to say it's a GameStop type of case, but the Canadian rally is not entirely based on fundamentals. But when we talk to clients, we tell them careful trying to short these Canadian names because you know what happened with GameStop on the way up."

In contrast, the S&P 500 remained relatively flat this week, as Wall Street experienced a bout of listlessness in anticipation of another financial stimulus announcement from the US government.

Disclaimer: Past performance is not an indicator of future performance.

CannaStonks

While the attention of r/wallstreetbets has given a considerable boost to several pot stocks, it's important to remember that there are multiple elements which separate this scenario from the "GameStonks" fiasco.

To start with, many North American pot stocks were already steadily increasing in value, thanks to growing investor confidence following the election of Democratic President Joe Biden.

With cannabis stocks you have the new administration and the potential for legislation, a real fundamental item…to the extent that if there is a big change in some of those laws, it would be very favorable for those companies.Globalt Investments Senior Portfolio Manager, Tom Martin

Interestingly, much of the attention from retail investors has been primarily focused Canadian pot stocks, which is likely due to the current federal restrictions on marijuana, which stipulate that any cannabis company cannot be listed on a major American stock if they operate in a "plant-touching" capacity within US borders. 

Stock in Canopy Growth experienced a 12% spike this week, which was driven in part by the release of an earnings report which reported a decrease in adjusted losses for the quarter, while also predicting profitability by 2022.

The Canadian cannabis producer Tilray—which is currently in the midst of a reverse merger with Aphria (TSE:APHA)—also saw its stock experience a 50% boost on Wednesday. This marks an ongoing trend for Tilray, as its share price has experienced a 400% increase since the merger was announced in December.

"We are thrilled to bring together two cannabis industry leaders. At this nascent stage of development and expansion of the global cannabis market, we believe companies with leading geographic scale, product range and brand expertise are most likely to benefit long-term," Tilray CEO Brendan Kennedy said.

"By leveraging our combined strengths and capabilities, we expect to be able to meet the needs of consumers more effectively all over the world and advance patient care.

"With a strong financial profile, low-cost production, leading brands, distribution network and unique partnerships, we believe the Combined Company will be well-positioned to deliver sustainable, attractive returns for stockholders."

Similarly, Aphria stock has experienced a 243% increase in value since the merger was announced, as investor sentiment has continued to grow on the back of decriminalization hopes following the Democrat's victory in the Senate.

Additionally, Sundial Growers (NASDAQ:SNDL) share price experienced an 161% week-on-week gain after a midweek increase of 80%, while Aurora Cannabis rose by roughly 20%, bringing its year-on-year growth to 120%.   

However, it is important to note that many of these pot stocks subsequently dipped in value on Thursday, as retail investors began to get cold feet about the previous day's buying frenzy.    

"The market has a pretty bad case of ADHD these days, and the latest shiny object for what has been a rabid retail crowd is cannabis stocks," Morningstar's Global Director of ETF Research Ben Johnson said.  

"The all-important question is whether all of those fundamentals, all of that enthusiasm is priced into the shares or not."

Disclaimer: Past performance is not an indicator of future performance.

Looking Ahead

Unfortunately for shareholders, Tilray took a hard hit from the retail investor backpedal, and by the close of trading Thursday its stock price had fallen from 63.91 to 32.16, although it subsequently began to rally before the week's end.

This level of wild volatility is relatively out of the ordinary, though not entirely foreign to Tilray. In fact, the pot stock's spectacular climb this week was highly reminiscent of a similar incident in late 2018, when Canada's upcoming legalization of cannabis sent the company's share price surging to an intraday high of $300, before it eventually tapered down to a more stable level.

And according to the head of research at London Capital Group, Jasper Lawler, while other investment analysts were considering the potential long-term outlook of a Biden presidency, he had elected to focus on "splitting the outlook in two".

"The involvement of Reddit means a frenzy is the right word. Reddit targeting a short-squeeze in Tilray means a quick pump and dump," Lawler said.

Many expect the regulatory reform that has been touted by the newly-empowered Democratic Senate could help push US cannabis company valuations even higher in the coming months, as legislative changes could see pot stocks gain access to more traditional methods of banking, or even the decriminalization of marijuana at the federal level.

Although, retail investors should exercise caution before diving in too deeply, as there are signs that these increasingly large valuations are becoming unjustifiable in scale, particularly when the global cannabis market is still in such a volatile state. Furthermore, it is important to remember that Canadian cannabis companies like Canopy Growth and Tilray may not necessarily experience a direct positive material impact from changes made to the US regulatory environment.

"Hedge fund short sellers have been put on notice by the Reddit movement: any highly shorted stock could be subject to a coordinated squeeze," BCMI Research President Chris Damas said.

"Well, yesterday, the shorts in Canadian cannabis were definitely spooked in a big way, and rushed to the exits to cover their positions and lock in huge profits."

"The market does not care about fundamentals right now. It's all about short covering."

Disclaimer: Past performance is not an indicator of future performance.

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Hugo Gray
Hugo Gray

Hugo Gray is a Melbourne-based journalist with a body of work that covers a diverse range of topics, including immigration law, sex technology, and now the rapidly expanding cannabis industry.