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Many of them were first-time traders, who dove into the cannabis stock frenzy without grasping the risks involved.

Sean Kilpatrick/The Canadian Press

The crash in cannabis stocks has pushed Justin Caron into the role of grief counsellor for bereft investors facing disastrous financial losses.

Many of them were first-time traders, who dove into the cannabis stock frenzy without grasping the risks involved. Now that the bubble has popped, their trading accounts are decimated and they don’t have a plan to stop the bleeding.

“They’re ashamed,” said Mr. Caron, who runs Blaze Capital, a cannabis investing group based in Vancouver. “A lot of them would rather disappear into the shadows and never talk about their losses because it's too embarrassing and painful.”

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The average cannabis stock is now down by about 60 per cent over the past eight months, wiping out nearly $60-billion in market capitalization from a group of 90 Canadian and U.S. stocks, according to S&P Global Market Intelligence.

There were ample warning signs the cannabis space was wildly overheated. But the rare opportunity to get in early on the establishment of a brand new legal industry proved irresistible for many mom-and-pop investors.

Every asset bubble starts with a compelling story. With the legalization of marijuana in Canada, the creation of a multibillion-dollar consumer sector captured the imagination of the masses, said Mark Kamstra, a York University finance professor who studies asset bubbles.

“You get people telling stories to each other and there’s a fear of getting left behind,” he said.

Quick money made in the early stages of a bubble reinforces the exuberance. From most of the stretch between 2016 and 2018, it was difficult to not make money in cannabis stocks.

“All you had to do was throw a dart,” Mr. Caron said. Invest in almost any cannabis name, and in six months, your investment at least doubled.

In that kind of environment, the fundamentals of valuation go by the wayside. At its peak in April, Canopy Growth Corp. hit a market value of $24-billion, making it roughly the same size at Loblaw Cos. Ltd., which brings in more than $48-billion in revenue a year. Canopy’s top line is less than 1 per cent of that.

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Rookie investors lured in by runaway gains got fooled into thinking investing is easy. “They were not buying with 5 or 10 per cent of their portfolio, they were going all in,” said Mr. Caron, who runs a subscription-based Slack forum for retail cannabis investors.

The financial industry, meanwhile, did its part to stoke enthusiasm. Equity analysts at Canadian brokerages got more bullish as the market went up. At the time the sector peaked in March, roughly 87 per cent of all analyst ratings on Canadian cannabis stocks were “buy” recommendations. Just 4 per cent were “sells,” while the remainder were “holds.”

The cannabis companies themselves, meanwhile, aggressively promoted their stock to the retail investing community. And a handful of Canadian hedge funds used a financial manoeuvre that made it appear as if equity financings had institutional investor support. In many cases, these funds shorted the same stock prior to the deal. That way, they could, in effect, earn a discount by covering their positions when the deal launched.

In reality, the marijuana stock mania was largely fuelled by retail money.

“The money made out of the bubble is used to further inflate the bubble,” said Michael Decter, president of Toronto-based boutique investment firm LDIC Inc. “And then investors start asking why they don’t have Canopy in their accounts.”

That exuberance backfired badly after marijuana was officially legalized nationally a little more than a year ago.

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The retail rollout was riddled with problems, including supply shortages and product quality. The industry, meanwhile, has relentlessly added production capacity, setting up a supply glut while facing a limited retail network. In Ontario, there are just 24 retail stores in operation.

At the company level, meanwhile, a string of regulatory and compliance issues has cast a pall over the business. After CannTrust Holdings Inc. was caught growing cannabis in unlicensed greenhouse rooms, Health Canada suspended the company’s licences.

On the operational side, the rampant growth that sustained investor optimism has vanished. The country’s two largest producers, Canopy and Aurora Cannabis Inc., reported quarterly sales declines of 15 per cent and 24 per cent, respectively, a little more than a week ago.

“This business just wasn’t ready for prime-time,” said Elliott Fishman, director of U.S. and international equity trading at Scotia Wealth.

Very little investor money is now going into cannabis names through Scotia’s retail platform, Mr. Fishman said. Suddenly starved for capital, companies that need money have had to resort to debt financing with hefty interest rates.

Amid that brutal reckoning, many cannabis shareholders have ridden their holdings all the way down. “It's pretty common for the retail investor just to hold on until the bitter end,” Mr. Kamstra said.

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Inexperienced investors not only dramatically overexposed themselves to a speculative sector, they also did not have a plan in place in case of a sell-off, Mr. Caron at Blaze said. Facing losses of 50 per cent or more, they consider their only option at this point to be holding out for a recovery, he added. “A lot of people are saying they don’t even want to log into their accounts."

Last week provided a glimmer of hope after a vote in the U.S. House of Representatives took one step toward a federal decriminalization of cannabis.

Over three trading days, the Horizons Marijuana Life Sciences Index ETF, which holds more than 50 cannabis names, rose by 20 per cent, leading to some optimism that the bottom was in the past. On Friday, however, the sector-wide sell-off resumed. “I think there’s zero chance of a rally back above their previous highs,” Mr. Decter said. “This is a permanent hit.”

Once a generator for lucrative short-term gains, cannabis investing is shifting toward a more fundamental model. Investors will need to separate the probable winners from the losers, pay attention to valuations, and focus on the path to profitability, Scotia’s Mr. Fishman said.

“It’s a different sport from here.”

With a report from David Milstead

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