Could a drop in Canadian cannabis stocks drive investors to U.S. cannabis stocks?

QUESTION: “Following up on the Let’s Toke Business newsletter of May 27, 2019, if the incumbent Liberal government and Prime Minister Trudeau lose the next Canadian election and the Canadian cannabis stocks go into a bear market, do you believe the global cannabis stocks will also drop? Could a drop in the stocks of Canadian based cannabis companies drive investors into U.S. and International cannabis stocks?”

S.K. from Chicago, Illinois

ANSWER: The Canadian and U.S. markets tend to move in tandem in the long run. This chart shows the Toronto Stock Exchange as measured by the S&P/TSX Composite Index and the Dow Jones Industrials plotted side by side. It shows a couple of things. The ups and downs in prices match up fairly well. There are reasons for this. First, the Canada/U.S. border is theoretical in many ways. Our legal systems, our economic infrastructure and our social norms are fairly close. Second, the U.S. is roughly ten times larger than Canada so our position is often likened to sleeping with an elephant. When the elephant rolls over, Canada gets squashed which is to say we are often at the mercy of that the Americans do with important stock market variables such as money supply, interest rates, monetary and fiscal policy and so on. Second, what the chart shows in the period under review is that American stocks have far outperformed Canadian stocks which is approximately 1980 to the present. Part of this is because although we are very similar, we are also different. Canada is a far more resource oriented economy. At times this is good but in the past three or four decades, not so much. Also, the U.S. economy is a more free market, meritocracy. Canadian tends to be more socialistic. We need higher taxes to pay for our social programs such as universal health care.

When it comes to cannabis, however, those differences become a little more moot. The next chart shows the performance of the Canadian based cannabis operators compared to the U.S. based operators using the Canadian and U.S. Marijuana Indexes owned and managed by MJIC. Acknowledging the fact that there isn’t as much data available, if the stock prices of the Canadian and U.S. operators performed exactly alike, there would be a flat line across the chart. As it rises to the right as it did from approximately 2015 to early 2018, it means the shares of companies operating primarily in Canada were performing better. If the chart falls to the right it means the companies with operations in the U.S. were performing better. One other point to remember. This chart does not tell you if the stock prices were moving up or down. It only tells you that the one group’s share price was doing better than the other.

What this says to me is that just because the companies operating in Canada are negatively impacted by local political events, it doesn’t mean the U.S. ones will perform negatively as well. To me it is like expecting the U.S. bank stocks to drop just because the Canadian banks are performing poorly. As a result, if I am correct and Canadian politics throw the Canadian based operators into a downward spiral, there is no reason to expect the U.S. based cannabis operators will do the same. Clearly they can perform differently and, as the chart shows, they already do.

The same rationale applies to international operators. In this case, I would expect any linkage in performance to be even weaker. There is less commonality between Canada and Colombia, Germany or Australia than there is between Canada and the U.S. So international operators should be less correlated to Canadian operators.

Financial flows are critical in today’s world. For example, when interest rates in the U.S. go up compared to Canada, the U.S. dollar goes up relative to the Canadian dollar. The reason is Canadian investors will move into U.S. securities to get the higher interest rates. When they do that, Canadian investors buy U.S. dollars and sell Canadian dollars to make the investment. It’s the kind of thing you see all the time in the financial markets.

The one thing I know that still causes some confusion out there is where a stock is listed. Don’t forget, where a company’s shares are listed does not normally impact where it operates. So if you look at where our companies are listed, it varies between Canada and the U.S. Some on the Toronto Stock Exchange or Toronto Venture Exchange and some on the New York Stock Exchange or the USOTC market. But you have to do your due diligence to find out where the company does the bulk of its business.

Conclusion: I believe that unless something completely unexpected happens in the next few months, the pro-cannabis Liberals are going to lose to the anti-cannabis Conservatives and this could be the trigger that sends the shares of companies operating primarily in Canada into a bear market. But this does not mean the shares of U.S. and international operators will fall into a sharp decline. They can and will perform differently in my opinion. That is one of the primary variables underlying my choice of common stocks The individual stocks in my list have been developed with this non-Canadian theme in mind: 1933 Industries (CSE: TGIF) (OTCQB: TGIFF), Cannabis Growth Opportunity Corp. (CSE: CGOC), Khiron Life Sciences (TSXV: KHRN) (OTCQB: KHRNF), Lexaria (CSE: LXX) (OTCQX: LXRP) and Sunniva (CSE: SNN) (OTCQB: SNNVF). This week I want to draw your attention to Khiron that might have been unduly influenced by a very misleading and poorly written report. (see below)