Juggling Dynamite

Some sober thoughts on the current pot-co mania:

Canada’s cannabis companies are experiencing a rush of investment that’s making even some participants paranoid.  Here is a direct video link.

As cryptocurrencies and their companies continue to plunge–the sector’s down 68% since January 1, 2018–stories abound of individual would-be-investors gamblers that have been wiped out.  Again.  It doesn’t have to be this way.

There’s nothing new here, just all the usual suspects:  a hot idea heavily sold to the gullible, who bet money they can’t afford to lose on the hope, against all odds, that they might win.

As one bubble crashes others are always being born, and most recently it’s in the area of marijuana.  Pot-related companies are buying up the booths and sponsorship on financial media and investment conferences the way that crypto-cos did last year, and commodity companies in 2008.  Everywhere we turn, people are selling others on the dream of striking gold in pot.

There’s no doubt that legalized pot is an idea whose time has come to North America and there will be companies who profit greatly.  That said, statistics warn that some 80% of current start-ups will have vanished within 5 years, and the vast majority of shareholders in this space will lose money.

Like dot.com stocks in 2000, precious metals and the China bubble in 2007,  pot is just the next speculative mania waiting to pummel the unsuspecting.

To survive the madness of crowds, we must never forget that great products and ideas are frequently bad investments. And risk rules that control any exposure amount and timing are the most defining criteria of our longer-term financial success or failure.

We discussed these concepts in our November 2017 client letter (available here) written 2 months before the crypto-bubble burst, and they are directly applicable to pot stocks today:

“…great ideas or products frequently prove devastating investments depending on the price paid and timing.  It is one thing for IBM, Credit Suisse or governments to allocate portions of their Research & Development budgets to develop blockchain and improve their operating efficiency.  It is something else entirely for individuals to bet their savings that shares of one or another developer, service provider, or alt-coin, may go up in value before they need or want to sell it.

With no income flow or asset backing of any kind, cryptocurrencies can’t be valued as an investment and are the very definition of speculation. If one is interested in speculation, then like when heading to a casino, it is critical to limit our wager to a defined amount we feel comfortable losing, without any negative effect on lifestyle, future goals or peace of mind.

As usual, the loudest proponents of a financial product or investment theme are typically those in the business of selling it to others (in exchange for our cash). As in all things, if we are taking our buy advice from those who are paid to sell us the products, we are putting ourselves and capital in harm’s way.”

Rivets are starting to blow once more on the debt-on-debt Ponzi driving Chinese markets.  Following the lead of western companies, corporate buybacks in China have surged in 2018 (see left).  This is the latest desperate effort to stop asset bubbles from following their natural destiny to implosion.

See the WSJ’s Record Buybacks Don’t Mean Buy in China. Chinese companies are spending record amount on buybacks. This is not a sign of confidence:

One reason some Chinese companies are doing buybacks is because Beijing has been encouraging them to do so in the hopes of boosting the Shanghai Composite Index, which has slumped 25% since its January peak. The country’s stock-market regulator last week proposed rule changes to make it easier for companies to repurchase their shares.

Another factor behind the surge in buybacks relates to the sheer amount of stocks used as collateral for loans in China. Major shareholders of Chinese companies have collectively pledged some $700 billion of stocks in return for loans, according to Wind Information. With many small companies’ shares having fallen 30% or more this year, a further drop could trigger margin calls on those loans—hence the need for buybacks to support stock prices. Around a third of the companies that have bought back shares this year have more than 30% of their stock used as collateral for loans.

It’s ironic that The Wall Street Journal article points out buybacks are not a sign of confidence in China, because they aren’t in America either.  In both places, buybacks at record valuations are a sign of too much debt-manufactured liquidity with too few legitimate investment opportunities in a slow-growth economy–short-term gimmicks to buy longer-term capital losses.