As we continue in the eleventh year of economic expansion since the financial crisis, many investors (myself included) believe that we may be headed for difficult times in the next 12-24 months. If the market continues to turn, I would be very wrong, but the trade in long gold and short cannabis is one that I think represents changing feelings in the markets. I think this trade will continue to function well in the next 12-24 months.
Gold is perhaps the oldest cover for anything based on a flat currency. Gold represents a stable store of value and is global in nature. During the latest financial crisis, the Federal Reserve in the United States printed a ton of money via a quantitative easing and pumped this liquidity into the financial markets. The result was a devalued US dollar. Since it would take more US dollars to buy an ounce of gold with a weaker dollar (gold prices are based on US dollars), the gold price has shot up. Therefore, gold is an excellent cover for general market weakness. Gold is also an excellent hedge for the depreciation of the US dollar. This is important if you have a significant portion of your assets dominated in US dollars.
I think this economic expansion is getting long in the tooth. Therefore, I think gold is still cheap, despite its slow and steady increase in recent years. I would suggest that investors look to one of the various gold traded funds (ETFs) or to a large gold producer like Barrick Gold by exposure. The fact that the cannabis industry has been so weak in the past 12 months is indicative of the aforementioned changing sentiment. This feeds my belief that we are approaching the end of this expansion. The main reason why I believe this trend will probably continue is the low supply and demand in the cannabis sector. I will use the example of the largest Canadian cannabis producer Canopy growth (TSX: WEED) (NYSE: CGC).
Currently, Canopy Growth has approximately 20% of legal cannabis sales in Canada. This company also produces enough legal pots to meet 50% of Canadian demand. This is based on the latest published financial statements, indicating that Canopy produced 183 tons of cannabis but only sold 70 tons of cannabis. The fact that Canopy has enough grass available and in its production pipeline to last two and a half years means that the company will have to make some difficult decisions. These could include whether to destroy the product, drastically reduce the price to sell inventory, cut jobs, incur write-downs and / or close production facilities.
With Constellation Brands Having a massive stake in Canopy, I expect to see some serious cost containment initiatives put in place in the coming quarters. This is a trend that I expect will reverberate across the industry, as these supply and demand problems are not exclusive to Canopy.
When we begin to see serious divestitures, plant closings, layoffs and devaluations (it has just begun), for many cannabis bulls the reality will occur that this is no longer an area you would like to be in. Instead, invest in gold. This is what the market says after all, loud and clear.
Stay foolish, my friends.
Motley Fool owns shares and recommends Constellation Brands. Fool collaborator Chris MacDonald does not own any of the actions mentioned in this article.