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Cannabis stocks up in smoke even as Congress pushes legalization


FILE - In this Jan. 6, 2018, file photo, an employee stocks cannabis at a store shortly before its first day of recreational marijuana sales in San Francisco. California has endorsed a rule that will allow home marijuana deliveries statewide, even into communities that have banned commercial pot sales. The rule finalized Wednesday, Jan. 16, 2019, by state officials was opposed by police chiefs and other critics who say it will create an unruly market of largely hidden pot transactions and encourage potential criminal activity. (AP Photo/Noah Berger, File)
FILE - In this Jan. 6, 2018, file photo, an employee stocks cannabis at a store shortly before its first day of recreational marijuana sales in San Francisco. California has endorsed a rule that will allow home marijuana deliveries statewide, even into communities that have banned commercial pot sales. The rule finalized Wednesday, Jan. 16, 2019, by state officials was opposed by police chiefs and other critics who say it will create an unruly market of largely hidden pot transactions and encourage potential criminal activity. (AP Photo/Noah Berger, File)
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The marijuana industry has gotten a huge amount of attention and publicly traded cannabis companies have racked up billions of dollars in investments. But over the past six months, their fortunes have, well, gone to pot.

Valuations began to peak after Canada legalized marijuana in 2018. Over the past year several of the most promising cannabis companies have seen a dramatic decline, losing two-thirds of their value. In the past six and a half months, the top 15 cannabis stocks have lost $35 billion in value, according to the Motley Fool.

There was a brief respite from the marijuana firesale this week. On Wednesday, the House Judiciary Committee voted to advance the first-ever piece of federal legislation that would end the prohibition on marijuana. Two Republicans joined 22 Democrats to pass the MORE Act, 24 to 10. It now goes to the full House of Representatives for consideration.

The bill's lead sponsor, Rep. Jerrold Nadler, D-N.Y., described the legislation as "long overdue" and "the right thing to do." The National Cannabis Industry Association (NCIA), advocates for cannabis businesses, said the vote was "an unmistakable sign that the debate over legalization is moving from 'if' to 'how.'" NORML, the National Organization for the Reform of Marijuana Laws, described the Wednesday vote as "the biggest marijuana news of the year."

Investors shared the optimism. Pot stocks briefly surged. Several of the top companies posted double-digit percentage gains, though not nearly enough to make up for recent months' losses. There was a similar high-spirited reaction in September, when the House passed the SAFE Banking Act, to allow banks to work with cannabis companies, including providing loans and other business services. The bill would remove a major roadblock for legitimate cannabis businesses and it is now awaiting consideration by the Senate Finance Committee.

"We see upticks in the investment market pretty much anytime progress is made legislatively—either at the state level or in Congress," explained Morgan Fox of NCIA. "Then the reality sets in that this is an emerging market with a lot of pressures put on it that other markets don't necessarily have to deal with."

WHY POT STOCKS ARE LOSING

Even with the promise of congressional action on the horizon, the industry is saddled with the uncertainty of a federal ban on the product and massive costs that many investors did not anticipate when they were pouring billions into the nascent cannabis industry.

"There's this general notion that the cannabis industry is an instant goldmine," said Tom Nolasco, the legal director at the National Association of Cannabis Businesses. "The reality is, if you want to get into this business and be successful, it's very expensive."

Without legal access to the banking system and regular business loans, any budding company has to start off with a lot of cash or some generous investors. States often charge hefty licensing fees before allowing a company set up shop. Companies in states that have legalized the sale of marijuana have to pay a sizable sales tax and cultivation tax. They also don't have the benefit of writing off business expenses, so everything from cultivation equipment to payroll and office supplies drives up costs.

That has been the harsh reality for many of the players in the cannabis industry who are burning through cash as they try to build and expand their companies faster than they can turn a profit.

Another problem is the inescapable fact that the product literally grows like a weed. States, like Oregon, have seen an oversupply of marijuana and an inability to sell to consumers at prices that are competitive with the illicit market. Canada, One problem that has hit Canada, which legalized adult-use marijuana in October 2018, has been suffering a nationwide glut. In recent months, there were reports of warehouses stacked with pot, because the Canadian distribution network was still in its infancy while cultivation was booming.

On top of those challenges, the cannabis industry has expanded dramatically in recent years from several players to several hundred. These companies cover the waterfront of CBD and hemp products, derived from the cannabis plant but without the psychoactive chemical THC, to premium marijuana and vape products, which were hit hard after the nationwide health scare associated with vaping.

Bruce Perlowin, the current CEO of Hemp Inc. and the founder of the first-ever publicly traded cannabis company compared the explosion in pot stocks to the dotcom bubble. "There are too many of us," Perlowin said. "I think the downward trend is too many companies and not enough buyers. And stuff like that changes on a dime."

Many analysts are anticipating a major shakeout in the near future. One industry-watcher acknowledged that there are many companies trying to position themselves to be the dominant players in the industry, but until cannabis actually legal, "a lot of it is built on a foundation of sand."

The legal and regulatory confusion has impacted all aspects of the cannabis industry.

Federal regulators with the Food and Drug Administration and Federal Trade Commission are cracking down on companies involved in CBD products. The regulatory agencies have sent several warning letters to CBD companies in recent months for making unsubstantiated claims about their products. One Florida-based company was selling CBD products online claiming they could treat teething pain and earaches in infants, autism as well as Parkinson's disease and Alzheimer's. Other companies have claimed their products can cure or prevent cancer, raising consumer protection issues.

Currently, the FDA has approved just one CBD product and is still exploring ways to allow CBD supplements and products to be marketed lawfully.

Hemp cultivators are also under pressure to comply with the 2018 Hemp Farming Act which removed hemp from Schedule 1. The law allows industrial hemp cultivation, which some optimists have said could someday replace plastics, but strictly limits the THC content of the crop. These strict regulations have raised concerns producer compliance and the threat of federal penalties.

HIGH HOPES FOR FUTURE GROWTH

The challenges facing the cannabis industry have a lot of investors heading for the exits and many once-promising companies having to shut their doors, as has been the case any other time a hot market cools. "It's just like the old adage with risk and reward," Nolasco said. "There is still a lot of risk in this industry but when you have that, you have the opportunity for some people to do very well."

Not everything is doom and gloom in the world of marijuana. Some experts suggest the pot stock burnout may only be temporary, a bump in the road for a nascent industry struggling through unique legal and regulatory challenges.

Overall, the potential for growth is huge. Earlier this year New Frontier Data, a cannabis industry research firm, reported that legal sales of cannabis products in the United States topped $10 billion in 2018. According to their projections, the legal cannabis market is on track to hit $30 billion in 2023 and expand to $66.3 billion by 2025.

States and the federal government are also looking at the revenue they could generate by taxing cannabis sales. Several estimates suggest the tax revenue from recreational marijuana would likely rival tax revenues from beer, liquor and tobacco—each of which generates between $10 to $13 billion per year. In the five years since it legalized marijuana, Colorado has raked in more than $1 billion in tax revenue, though some question whether the benefits outweigh other concerns, such as increased reports of drug-impaired driving.

Virtually every state that has a legal market for medical or adult-use marijuana is doing very well, Fox said, generating hundreds of millions of dollars in sales. The numbers are impressive, he said, "but it's not as much as they could be doing if the federal landscape were better and if states work a little closer with the industry to determine where the balance point is with taxation and fees."

Much like the performance of the cannabis industry, the path to legalization remains rocky and uncertain. The MORE Act to end federal marijuana prohibition has the support of several senators running for the Democratic presidential nomination. Elizabeth Warren, Kamala Harris and Cory Booker co-sponsored legislation in the Senate that matches the House bill.

At the same time, Republican Senate Majority Leader Mitch McConnell has voiced his opposition to legalizing cannabis, even though he sponsored the bill to legalize hemp cultivation last year.

NORML political director Justin Strekal noted McConnell could always "evolve" on the issue, as he did when he became a lead proponent of the bill to end hemp prohibition.

"When we look at the Senate map in 2020, some of the most endangered Republicans are in states that have legalized adult-use marijuana or states with ballot initiatives for adult use next November," Strekal noted. "Just as we saw McConnell evolve rapidly on the issue of hemp last December, it's not an absolute zero possibility that he could move this forward for political purposes."

Medical marijuana is currently legal in 33 states and Washington, D.C. Cannabis is legal for adult recreational use in 11 states and D.C.




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