Since I last wrote to you on February 28, cannabis stocks have fallen nearly 14%, using the AdvisorShares Pure U.S. Cannabis (MSOS) as a proxy for the group.
There are certainly good reasons why “the doubts” have crept back into the minds of cannabis investors, which I will explain in a second. But my take is that by now, the concerns may be fully priced in, so the group looks like a solid buy.
What to Do Now
With the March weakness, cannabis stocks have fallen enough to consider entries again. In a volatile group like this, it always makes sense to plan entries in phases, to average in. I suggest considering any of our portfolio names, with a focus on the MSOS and its leveraged twin, below, if you want to keep things simple. Be careful with leverage. The heightened volatility it causes can shake you out of positions at the wrong time if you are not emotionally prepared for it.
Portfolio names are: Ayr Wellness (AYRWF), Cresco Labs (CRLBF), Curaleaf (CURLF), Cronos (CRON), AdvisorShares Pure U.S. Cannabis (MSOS), AdvisorShares MSOS 2X Daily (MSOX), ETFMG Alternative Harvest (MJ), Green Thumb (GTBIF), Organigram (OGI), Tilray Brands (TLRY), Trulieve (TCNNF) and Verano (VRNOF). For simplicity, consider getting exposure via MSOS or the leveraged version MSOX.
In a volatile sector like this, I prefer to add on weakness rather than strength. One of the reasons Cabot Cannabis Investor has outperformed so much over the past 18 months is that on several occasions I have taken advantage of sector weakness to lever up the portfolio (shift from MSOS and some stocks, to MSOX). Likewise, there will come a time to de-lever.
When or if we do get major rescheduling news from the Drug Enforcement Agency (DEA) in the form of a proposed rescheduling rule, that will create a rally in which to trim positions and de-lever a bit. De-lever in this instance will mean trimming MSOX and putting the funds into cash or the MSOS.
Reasons for “The Doubts”
The context here is that the Health and Human Services Department (HHS) has asked the DEA to soften its stance on cannabis by downgrading it to Schedule III from Schedule I under the Nixon-era Controlled Substances Act (CSA).
The change would help cannabis companies by boosting cash flow enormously. The reform would lift cash flow by exempting companies from an Internal Revenue Service rule (called 280E). This bars the deduction of operating expenses against Schedule I drug revenue.
The next step in rescheduling should come in the form of a proposed rescheduling rule from the DEA. This is the big news cannabis investors have been waiting for. The timing is critical. It has to happen by March or April for the Biden administration to reap election-year boasting rights – part of the plan here. The rule needs to come out by March or April to allow enough time for comments and hearings needed to approve rescheduling before election day, or at least inside the current administration.
Because of the importance of this catalyst to cannabis investors, it was a big negative to learn last week that a party to rescheduling asked the Justice Department’s Office of Legal Counsel (OLC) to weigh in on the change. The OLC is a kind of an internal, administration law firm. I’ve heard about this development from a regulatory source in Washington, D.C., and it was also covered in a Wall Street Journal article published on March 9.
Let’s consider the highlights.
The big problem for cannabis investors is that it is unclear exactly what the OLC was asked to opine on, or even who asked for the review. The Wall Street Journal says the HHS made the request. My source says it came from the DEA.
The upshot: There’s an extreme level of uncertainty here. Investors hate uncertainty, so they sell. Before I speculate on the reason for the request, let’s consider one thing we do know: The OLC review request brings in another party to rescheduling, which means at the very least it is bound to take more time.
“It adds a step to an already complicated process, and a decision maker that was not in the process before that everyone has to adjust around,” says my source. “The DEA could have a proposed rule sitting there. Getting the OLC involved presumably would slow things down because now they have to adjust their rule to reflect OLC conclusions.” For how long? “There is no straightforward answer,” says the source.
For what it’s worth, here’s my best guess about what’s going on. The DEA probably asked the OLC to opine on the big sleeper issue here: U.S. wholesale rescheduling of cannabis could be a violation of the 1961 United Nations Single Convention on Narcotic Drugs, which classifies cannabis as a Schedule I substance. If so, this would be bad news for cannabis investors because the OLC has been strict on the treaty issue in the past.
The UN treaty permits medical and scientific research use, but requires parties to “prevent the misuse of, and illicit traffic in, the leaves of the cannabis plant.” The CSA requires the DEA to follow the UN treaty.
There are ways around the treaty obstacle. One would be to simply ignore the UN treaty. That’s what Canada and Uruguay do. Heck, even the U.S. itself already does this as well, given how many states have legalized recreational use.
The UN has no real enforcement power. So there seem to be limited consequences. But there would be reputational harm in further treaty violations that the U.S. most likely wants to avoid, notes Ryan Scoville, an international law expert at Marquette University Law School. If the U.S. ignored this treaty, it could be hard to expect help from UN members in enforcing other treaties.
It’s also worth noting the DEA has a history of signing off on Schedule III classification of cannabis-based drugs, including Epidiolex, approved by the Food and Drug Administration (FDA) for the treatment of seizures; and Marinol and Syndros, FDA-approved for the treatment of nausea associated with chemotherapy and HIV-induced anorexia. Both drugs contain dronabinol, a synthetic form of THC.
Given the HHS conclusion in its rescheduling recommendation that there’s sufficient evidence that cannabis in general has medical uses, it’s possible the OLC or the DEA could consider that broad rescheduling of cannabis is not a UN treaty violation.
The bottom line: All of this is pretty murky, which explains the selling. However, at this point the uncertainty may be fully priced in. Given President Joe Biden’s reference to rescheduling in the State of the Union address last week, it is obviously a priority. Biden needs progress on cannabis reform to retain support among young voters, which has been slipping away. Rescheduling will not be easily derailed.
Other Catalysts on the Horizon
There are two other potentially meaningful catalysts on the horizon which could improve cannabis investor sentiment from here and push the group higher.
* First, there is chatter again that full Senate may take up the SAFER Banking Act, which would allow banks to serve cannabis companies. “There are good prospects of this legislation being passed in the next few months,” says Jefferies cannabis sector analyst Owen Bennett.
Senate Majority Leader Chuck Schumer (D-NY) said in a press briefing last week that the Senate is working hard to enact SAFER banking this year, and that there is momentum in bipartisan negotiations to get this done. Amendments have scuttled it in the past. But now, two amendments under consideration offset each other, in the partisan sense. One would support cannabis conviction expungements (the HOPE Act) and the other would support gun rights for cannabis consumers (the GRAM Act).
* Another near-term catalyst might come on April 1. If the Florida Supreme Court does not rule on the language of a proposed recreational-use legalization referendum by then, it automatically gets approved. It would then appear on the November ballot.
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