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What's the better buy: energy or marijuana stocks?

Kathryn Kyte
Which is better for your portfolio?
Which is better for your portfolio?

It can be a stock pickers market, but picking for a market that doesn’t exist yet can prove to be nothing more than a crapshoot.

Last week, Horizons ETFs Management Canada Inc. released the latest findings for its Sentiment Survey report, which asked Canadian investment advisors if they expect their returns to be bullish, bearish or neutral on 14 asset classes for Q3.

In Q2 of 2017, the team began tracking advisor sentiment for marijuana and the 2018 findings show that sentiment for marijuana was bullish in Q1, bearish in Q2 and is now bullish again in Q3. Investors are betting on the revenue potential from the Canadian recreational market when marijuana becomes legalized on October 17.

Overall 47 per cent of the responding advisors were bullish on Canadian equities. Under the S&P/TSX Capped Energy Index, 55 per cent of Canadian advisors were bullish with their outlook on energy equities and 53 per cent were bullish on crude oil, under the assumption oil prices will continue to rise in Q3. Advisors were bearish when it came to natural gas though, with only 35 per cent of advisors believing natural gas prices will rise.

As for the marijuana sector, under the North American Medical Marijuana Index sentiment was the highest: 58 per cent of advisors expect bullish performance from marijuana stocks. The Index’s performance figure is up 5.78 per cent.

“You have to assume that at some point in October there will be some sort of euphoria that will hit the news,” says Mark Noble, SVP of sales strategy at Horizons ETFs Management Canada Inc. “It’s sort of like an Apple launch and we’ve never really seen that in the investment marketplace. We’re really treading new ground in terms of what this means from an investment standpoint. Most of the time when we are looking at investments we’re trying to get into the brass taps of their balance sheets and determine what the stocks are actually going to do.”

“With marijuana stocks you’re betting on a concept or idea rather than a reality of what these companies are actually doing right now,” says Noble. “From an evaluation standpoint, these companies are extremely expensive but they are betting on a brand new sector that’s never existed before.”

Come October the world will be watching as a major developed economy unrolls recreational marijuana globally and because of its expected euphoria, Noble says we’ll see a bump in the evaluation of these stocks.

The case for energy

The energy sector is full of established businesses with revenue and although its performance has been “by far the worst performing sector in Canada for the last four to five years because of the decrease in energy prices,” Noble says that if Canada has any global disruption with Iran or the Middle East, WTI prices could go for anywhere around $80 a barrel, which would be a win since that number generally comes in around the $70 mark.

“If we start to see oil prices move north of $75 companies become more attractive, but it is heavily dependant on global forces propping oil up higher than $75 dollars a barrel, so some sort of macroeconomic event would need to happen,” explains Noble.

Noble also points to the economic growth seen with China, India and emerging Asia. As such growth has “started to really come online particularly over the last two years,” the need for oil to help with this growth continues so “there’s probably more demand for oil than there was three or four years ago.”

“You’re not going to find any cannabis stock that pays a 5.4 dividend like British Petroleum (NYSE:BP) does. And you’re not going to find any cannabis stocks that provide the dynamic stability that a company like BP does,” says Graeme Kirkland, senior investment advisor at Argosy Securities Inc., and formerly with BMO Nesbitt Burns and RBC Dominion Securities.

“The best of breed cannabis company, Canopy Growth Corporation, has approximately a $7 billion plus market cap in the cannabis space. BP has a market cap of around $150 billion, that’s miles above the capital stability of any of the cannabis companies.”

Independent financial advisor Darryl Brown also sees benefits with the energy sector, pointing to energy supply and its triggers.

“On the supply side there’s voluntary curtailments from OPEC countries and their partners, which has put the industry in a very healthy state right now in terms of managing supply versus demand,” says Brown. “I think that’s been positive for the energy price over the last two to three years. You even have aspects where there are supply disruptions, which is a constant thing with global energy in that you always have the prospect of geopolitical flare ups affecting the global supply of energy. This is a positive crisis.”

The case for marijuana

It’s very early days in the marijuana sector, but with Canada as a global leader, Canadian companies have a distinct advantage and that’s exciting.

“A lot of the marijuana companies that are based in Canada, they’re really the world leaders, not only being first in terms of growing and distributing marijuana, but also first to get a lot of global markets’ funding, they have big amounts of cash they can use to acquire and expand their businesses and that’s a much bigger market” says Noble, who notes the importance of the medical market industry and how lucrative this market could be. “That could be anywhere from a $50 million to $70 million market just because of the pharmaceutical aspect. However, there are a lot of unknowns.”

Kirkland says the growth potential is enormous for marijuana and “the world is moving towards solar and electric, Elon Musk, like him or not, is a force to be reckoned with,” he says. “The really exciting thing about marijuana is the potential good for human kind, aside from getting stoned and relieving stress. I think it’s very respectable what’s going on with this industry.”

Furthermore, “if an investor wants super growth and can tolerate downside, cannabis is good to own,” Kirkland adds. But Kirkland notes that “if an investor has a low risk tolerance, whether they’re 20 or 40 or 80 years old, they shouldn’t own cannabis.”

But there’s risk in energy too and as Brown quips “what happens if the price of energy goes from $68 to $34?” Brown notes there are many longterm headwinds when it comes to energy.

“On the demand side vehicles are getting far more efficient, there are new technologies and purely electric vehicles, all of which are zapping demand for crude oil. There’s an increase focus on carbon emissions and climate change so that weakens oil demand,” says Brown.

“The American energy complex dream of the suburban house, two cars, 45-minute commutes—this whole complex is eroding at the moment,” Brown adds.

The case of the unknowns

Unknown conditions coupled with strict regulations means marijuana investors need be patient with their expectations on revenue and earnings.

“It’s a heavily regulated industry both domestically and internationally so there’s not a huge catalyst for unknown information to come out. The ones that are going to relax regulations around recreational use are known and priced in already,” says Brown.

Despite marijuana regulations, Brown sees longstanding opportunity. “You have an industry that is just being born, and the pool for cannabis is getting bigger while, in my opinion, the pool of energy is stagnant. It’s not getting smaller but it’s the same size at this point and I don’t see any catalyst for a huge long term demand for crude oil extraction.”

Another unknown that could play a part in marijuana stocks and their performance or underperformance, is the marketability of marijuana and what companies will be in the red and why. For Noble, the influence that marijuana could have on the market should be viewed also with how it attracts clientele on the consumer side.

“Marijuana that’s being sold at the recreational level becomes a consumer product, a marketing product. When you go into the cannabis store, I’m told there will be white non descrip’ bags so what is going to be the determinant that clients pick something? Is it going to be based on price? Are they looking for marijuana that is organically grown? Is there going to be a potency? We don’t know. It’s about seeing who the winners are and that’s when you’ll start to see disappointment from some investors that have been holding back from the single names or haven’t been able to convert their businesses to make money for the recreational market,” explains Noble.

The unknowns coupled with perceived forecasts while also slapped with strict regulations could be troublesome because of the variables. As an emerging market, investors will need to be aware that there’s going to be hiccups.

Energy stocks trade at low valuations, but pull in strong returns. Marijuana stocks are expensive and unpredictable, but have potential for huge growth. Both sectors can prove to be volatile.

Ethical and social responsibility implications

Marijuana may have a ton of potential but some investors still see it as a criminalized market. And some don’t. “We don’t know where it fits. Some people think it’s socially progressive and that it has benefits to society,” argues Noble. “There’s ethical components and it’s hard to know where it fits on the spectrum.”

“Marijuana is part of what I call a valued spaced investment sector. People put their money there because they believe in it and people apply their own values to marijuana so they feel more compelled to put their money behind it…that’s a very real way of expressing a political or valued space opinion and we definitely see that with marijuana. You don’t get the same sort of thing with energy. With energy you’re looking at ‘what’s the demand for oil’ and ‘is the evaluation of the company based on the demand for oil’,” Noble says.

If you’re going to go with marijuana, do it in moderation

“There’s no reason why marijuana should exceed two to three per cent of a diversified portfolio. It’s just one industry that exists among dozens in the world,” furthers Brown. “Just because there’s excitement and positive headlines doesn’t mean it doesn’t carry the same risk. It’s not going to be a get rich quickly industry, and even the top players in Canada, I question how quickly they’ll be able to make inroads in other countries where other private companies have tight ties to policy makers.”

“When investing in marijuana, is it exciting? Yes. Is it fun to watch? Yes. But you also have to look at it through a rational lens,” echoes Noble. “You have to recognize there are significant risks, but risk comes with rewards and opportunities too.”

Brown says it’s all about investing within a measured amount relative to the investor’s time horizon and their risk profile.

“But if I could only pick cannabis or energy and wake up in 20 years owning one of the two I would own cannabis. Hands down,” Brown says. “It wouldn’t be 10 or eight per cent of my portfolio though.”

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