Canadian cannabis stocks pop on U.S. legalization push and GameStop-style short squeeze

Shares in Canadian-based cannabis companies are surging this week partly because of a flurry of short sellers covering their bets against the stocks, right as U.S. lawmakers seem to be getting more serious about potentially legalizing the drug.

Three of the fourbiggest companies in the space Tilray, Aurora Cannabisand Aphria have seen their stock prices rise by between 30 and 40 per cent in the past two days. A fourth major player, Canopy Growth, is only up by about 10 per cent.

According to Chris Damas, president of cannabis consulting firmBCMI Research, the main catalystfor the run-up is a so-called short squeeze, whereby Wall Street investors that had been betting against the sector have had to buy up the shares en masse to cover their bets as momentum shifts back in favour of the shares.

Such a squeeze was the major factor in the GameStop saga of last week, where retail investors caught short sellers in a bind that pushed the price of the video game firm up almost 2,000 per cent before crashing back down.

• ANALYSIS:How Reddit squeezed GameStop to make short sellers lose their shirts

"Hedge fund short sellers have been put on notice by the Reddit movement: any highly shorted stock could be subject to a co-ordinated squeeze," Damas said. "Well, yesterday, the shorts in Canadian cannabis were definitely spooked in a big way, and rushed to the exits to cover their positions and lock in huge profits."

Prior to this week's run-up, almost one third of Tilray's shares were being shorted, or bet against. At Aurora, it was more than one in six, and at Canopy almost one in seven.

That's largely because after rocketing to all-time highs in the run-up toCanada legalizingrecreational cannabis in 2018, cannabis companies as a whole have seen their share prices sink as sales have so far not lived up to lofty expectations. Betting against overvalued cannabis companies has been a profitable trade for several years, but Damas saidmany on Wall Street are getting out while the getting is good, because the underlying problems at cannabis companiesremain.

"The market does not care about fundamentals right now," Damas said. "It's all about short covering."

Valid reasons for optimism

There are also perhaps some valid reasons for the optimism, too. Influential U.S. lawmakers led by DemocraticSenators CoryBooker, Ron Wyden and Chuck Schumer, said Tuesday they plan to introduce legislation to reform how cannabis is treated under U.S. law.

"Ending the federal marijuana prohibition is necessary to right the wrongs of this failed war and end decades of harm inflicted on communities of colour across the country," the senators said in a statement.

While more than a dozen states have fully legalized the drug and more thantwo dozen more have decriminalized it, cannabis is still a prohibited item at the federal level, which has held back investment in the sectorand been a drag on sales for companies that sell it.

Caryma Sa'd, a Toronto-based lawyer who works in the cannabis space, said in an interview Wednesday that the long arm of American law has long had a major influence on businesses in Canada, even those that are fully legitimateunder Canadian law.

In recent months specifically, she has noticed a growing trend of Canadian cannabis businesses having their social media accounts shut down because they refer to their cannabis-related business.

"These are perfectly legal businesses that have Facebookand Instagramaccountsare being shut down or being put into Facebook jail because they refer to their business," Sa'd said.

Legalization in the U.S., or anything approaching it, may well be a boon to Canadian cannabis producers, but based on her experience with the rollout here, Sa'd saidshe doesn't take it as a given that they would becomedominant in the American market.

"Looking at how they have fared in serving the Canadian market," she said."I'm not a gambler with stocks, and Idon't know that I'd put a whole lot of stock into that."