Short sellers are increasing bets on cannabis stocks even after summer selloff

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Short sellers have continued to build positions in the cannabis sector, even after a broad re-rating of risk following a steep summer selloff, according to financial analytics firm S3 Partners.

“Bearish speculators have strong conviction maintaining short exposure in the cannabis sector, despite the high borrow/carry costs,” said Matthew Unterman, director at the New York-based firm.

The cannabis sector has tumbled in the past few months as spooked investors began to re-evaluate its prospects amid a slower and more rocky-than-expected rollout of legal cannabis in Canada, which continues to be hurt by a shortage of stores.

Corporate governance scandals, such as the one involving illegal growing at CannTrust, and a regulatory clampdown on CBD products have added to the gloom.

In the U.S., the continued power of the black market and the reluctance of law-enforcement officials to crack down for fear of seeming to revive the war on drugs has hampered the development of the legal market. The continued federal ban on cannabis, and reluctance of federally insured banks to serve the sector, have formed another obstacle. A bill that aims to offer protection for banks has stalled in the Senate for now.

Sell-side analysts, who were mostly bullish at the start of the year, have started to rein in their recommendations and shave stock price targets.

“Rather than be wildly profitable in two years, we expect the Canadian LPs to be roughly break-even,” is how MKM analyst Bill Kirk summed it up in a recent note. “.. Companies with near-term funding needs may have difficulty,” he added.

Against that backdrop, short positions in seven of the better-known Canadian names have spiked higher, according to data provided by S3.

Short sellers take a view on a stock that it will fall in price. They then borrow the shares so they can sell them, hoping they can later scoop them up at a lower price, return them to the original lender and pocket the difference.

Short positions in Tilray Inc. TLRY, +3.77%, which is based in Toronto but listed only on Nasdaq, have increased to 38% of the float on Wednesday from about 22% on Jan. 1, according to S3 data.

For market leader Canopy Growth Corp. CGC, +2.41%  , WEED, +2.19%  which trades on the Toronto Stock Exchange and the New York Stock Exchange, short interest has increased to an aggregate 25% from about 14% in January.

At Aurora Cannabis ACB, +0.70%  , ACB, +0.64%  the most widely held cannabis stock which also trades on the TSX and NYSE, short positions now account for an aggregate 19% of the float versus 12% in January. At Aphria Inc. APHA, -1.35%  , APHA, -0.47%  also traded on TSX and NYSE, shorts account for 16% of the float compared with 15% in January.

At Hexo Corp. HEXO, +6.33%  , HEXO, +6.14%  which is dual listed on the TSX and NYSE, short positions account for 15% of the float compared with just 6% in January.

For Cronos Group Inc. CRON, +0.88%  , CRON, +1.24%  which trades on the TSX and on Nasdaq, short positions have grown to 26% of its float from 14%, while at Green Organic TGODF, -0.36% TGOD, +2.72%  which trades on the TSE and the U.S. over-the-counter market, short positions have climbed to 5% from 2%.

One bank is now betting that the worst is over and that stocks have bottomed out. Cantor Fitzgerald said Tuesday it expects positive catalysts to outweigh negative ones in the coming year.

All seven stocks tracked by S3 have lost ground this year, led by Tilray, which is down 67%. U.S.-listed shares of Green Organic Dutchman are down 57%, Hexo is down 37%, Canopy is down 29%, Aurora is down 26%, Cronos is down 19% and Aphria is down 12%.

ETFMG Alternative Harvest ETF MJ, +0.78%  has fallen 22%, while the S&P 500 SPX, -0.07%  has gained 23% and the Dow Jones Industrial Average DJIA, -0.20%  has gained about 18%.

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