Cannabis Sector Update:

Investors may have noticed some weakness in the shares of many marijuana stocks last week, including many penny stocks that have risen sharply in recent trading sessions. In all of our emails, regarding tracking stocks in the marijuana sector, we have stated:

“Please note that our decision to buy selected marijuana names is just based on our desire to ride the hype surrounding the sector and not an endorsement of their operations. In the long-term, most of the marijuana stocks being hyped will likely come crashing down.”

In general, shares have been able to dismiss negative commentary on the sector, including reports by Infitialis and Citron Research. We believe that at least two scenarios exist that could challenge the marijuana stock hype and potentially give us an indicator of when shorting very suspect names could become an option for our team.

Scenario One: Regulatory authorities drop the hammer on pump and dump schemes.

While its still too early to conclude that this scenario is taking form, it looks like the SEC may be heeding FINRA’s strong warning issued in early September 2013 regarding investing in marijuana stocks:

“Update: In early January 2014, new laws regarding the legalization of marijuana for medical and recreational purposes went into effect in a number of states. At the same time, media coverage of the issue increased, as did investor interest in shares of marijuana-related companies. In some cases, volumes for the stock of otherwise thinly traded, marijuana-related companies increased dramatically–and prices became quite volatile.”

“We are reissuing this alert to warn investors not only about the potential for fraud in this arena, but also to reiterate the risks of investing in thinly traded companies about which little is known. Regardless of industry sector, any so-called “hot” stock can burn your portfolio. Rather than getting swept away, take time before you invest to learn more about the company, its products or services and the people running it. And be sure you carefully assess the company’s prospects for success.”

On Friday March 14th the SEC halted shares of Petrotech Oil & Gas (PINK:PTOG) in the pre-market amid a flurry of promotional emails. It’s good to see that the SEC may be getting in front of pump campaigns earlier than they have in the past. The bad news for pump and dump investors is that the marijuana penny stock playing field could become riskier, especially with companies that have already attracted pump and dump campaigns, and/or have share structures that could attract pump campaigns. We are not attempting to create unnecessary fear for investors. But we feel investors should be fully aware of the risk involved of investing in these stocks as the market will surely go through a long filtering process to separate the fraudulent from the legitimate companies. This situation happened in the dot com era, it happened in the U.S. listed China space and it will happen again.

Scenario Two: Changes in regulatory landscape: Ironically, an improvement in the regulatory landscape that leads to cannabis companies being permitted to establish U.S. banking accounts could hurt the entire speculative space, flushing out a good majority of the weak players. The rationale behind this opinion is that this type of softening of the regulatory environment could attract much larger and established companies to enter the industry. For example, it is possible to assume that a company like Philip Morris could get involved. It’s worth noting that President Obama has

“…issued guidance to prosecutors and banks Friday meant to make it easier for legal marijuana sellers to open bank accounts.”

However this risk has to become real as observers have stated that:

“…the guidance fell short of giving banks carte blanche to get involved in a business that is legal in some states for medical or recreational purposes but is still illegal under federal law.”

We have updated our cannabis spreadsheet to establish which stocks have been or could be the recipients of pump campaigns. We are not writing this note to be sensational; we think it’s important for our members to understand the risk involved in investing in marijuana stocks until more clarity is available. During the dot com bubble, there was a period of time when every other penny stock decided to add dot com to their names. Time will tell if the SEC actions on PTOG is a sign of things to come. In the end we still think a few winners will emerge from the carnage.