It’s been an amazing 8-session run for the cannabis sector since August 15th. Piggybacking off Canopy Growth’s company massive $5 billion CDN investment—with optionality for another $4.5 billion if newly-issued warrants are exercised—much of the cannabis sector has soared to spectacular gains. But the euphoria must abate at some point, even if it’s only a multi-week respite.

Before delving into the reasons further, I must qualify by saying that technically speaking, the market looks fantastic. Bullish volume is still cresting, and there are no particular warning signals screaming “get out” (besides overbought conditions). I’m going out on a massive and unpopular limb here—neither of which I particularly enjoy doing. Be that as it may, I believe there certain conditions have materialized which should favor sell side conditions in the week ahead.

Thus, this outlook is part fundamental, part projection (as I see it), and part instinct gleaned from 20 years of market experience. It is not technically-driven, as many of our short-term forecasts usually are. But given the extreme nature of the cannabis price action, it’s something I feel needs to be written. There are thousands of investors currently embroiled in a Fear Of Missing Out (FOMO) mentality, just one impulse from deploying capital in an area which may be hazardous to their financial health. This article is intended for this specific cross-section of Midas Letter readers.

So without further ado, below we list five reasons why the cannabis sector could see more red than green next week; not necessarily on Monday, but on-balance. This tale of caution belies the amazing technical picture underlying the market presently, where indiscriminate buying is the market’s most important leading indicator. We especially hope this article provides further context for those debating whether to deploy capital at this mature juncture.

Canopy Growth Looks ‘Toppy’

What else can anyone say about the move in Canopy Growth? It’s been nothing less than breathtaking, having moved ↑86.00%, trough-to-peak, from the August 14th low. The move has been so intense, that it only took four sessions for Canopy to close above Constellation Brands share acquisition price of $48.60 CDN/share, and six to close above the new warrant exercise price of $50.40 CDN/share, vested three years out. Yes, Constellation sure knew what they were doing.

As historic as the move has been, all good things must come to an end. Perhaps more accurately, all good stock moves must consolidate. While the stock is certainly not flashing overt short term technical sell signals yet, there’s something important in the volume profile which caught me eye in the morning session:

Generally speaking, well-above average upside volume is exactly the type of thing you want to see for a move continuation going forward. But to me, this type of extreme upside volume at the highs of a massive move feels more like dumb money FOMO buying/short capitulation than smart money gobbling up shares. This is open to interpretation of course. But is it more likely that smart institutional money is deploying huge amounts of capital at record highs, or the later scenario just elucidated?

Coupled with the fact that Canopy Growth broke ’80’ in a bull-rush kind of way (as opposed to gradual and orderly) on the 20-period RSI this morning, it’s hard to envision how much upside remains in this bullish impulse. Only an equally impressive round of buying early next week can keep this train moving higher.

Dated Diageo Plc Rumors Power The Market

Just when you thought the market couldn’t get more frothy, mainstream business media stoked the fires further this morning. According to BNN Bloomberg, Diageo Plc is pursuing a deal with a Canadian cannabis sector, holding serious discussions with at least three major producers. Presumably, one of the suitors is Aphria Inc., which finished higher by $2.59 to $14.01/share (↑22.68%) by close. Of course, Aphria was a finalist in partnership negotiations with Molson Coors Brewing Co.—a deal which eventually ended up in Hydropothecary Corp.‘s lap as a joint venture collaboration.

Echelon Wealth Partners equity analyst Russell Stanley joins James West to chat about the Canopy Growth-Constellation deal and the mainstreaming of the cannabis industry globally

While the Diageo Plc news is additional fantastic news for the sector, it’s also the worst kept secret on Bay St. Rumors of Diageo’s interest in the marketplace have swirled for several weeks, albeit out of the public limelight. In July, Diageo’s corporate relations director, Dan Mobley, stated the cannabis sector in North America was “still [in] very early days… We are monitoring very closely and seeing how the market is evolving.” Molson Coors back in February identified cannabis as a risk to their long term operating model. Everybody following the sector knows Big Alcohol is ready, interested, and imminently about to join the party.

So while FOMO money laps this quasi-known ‘news’ up and bids up stocks even higher, it’s a smart assumption that smart money is already selling into this euphoria (see chart above).

Peak FOMO out there, not going to end well till we consolidate — Vicious (@ViciousTrading) August 24, 2018

Most Tier-3 Cannabis Juniors Have Run

One of the most reliable predictors of short/intermediate cannabis sector tops resides in the trading activity of the Tier-3 juniors. The money almost always flows to the top first, filters down to the mid-majors, and eventually the juniors once larger cap upside movement gets too constrained. And right now, we’re at the point where most of the speculative LPs have participated in this Canopy Growth-inspired run.

The above chart speaks for itself. The most telling aspect that this bull run is getting ultra-mature is that some deep Tier-3 players have really begun making their move. More speculative LPs such as MYM Nuctraceuticals Inc., currently higher by $0.30 to $1.34/share (↑28.85%), are taking off sans material news. This is a tell-tale sign that pervasive FOMO has entered the market.

That’s certainly not the ideal time to deploy fresh investment capital in the sector.

Aurora Cannabis Australis Trade Is Complete

Before the bell on Monday, Aurora Cannabis announced a firm Distribution date for the spin-out of it’s American subsidiary, Australis Capital Inc. That date of record was set for Friday August 24, 2018, at which time Aurora shareholders of record will receive one future Australis Capital unit—plus one full share warrant exercisable at $0.25—for every 34 Aurora shares owned. Depending on where Australis Capital shares trade upon listing on the Canadian Securities Exchange next month, this gratuity could be a very lucrative endeavor.

Hence, it’s no secret that the Distribution has provided a heavy near-term catalyst for Aurora Cannabis stock. The Canopy Growth deal was perfectly timed, as it provided ideal cover for institutional investors to bid shares up and profit from the long end—all while receiving reward through Aurora ownership of record ending today.

While the ‘Australis trade’ provided a monstrous tailwind for the stock all week, there’s potential for short term weakness as the Distribution record date ends today. The institutions which piled-in to receive Australis shares will no longer necessarily beholden to positions purchased this past week.

I don’t necessarily expect dramatic or protracted selling, but Australis-inspired paring could act as a stiff headwind for the balance of next week. As the second most valuable cannabis LP by market cap, such headwinds could serve to dampen sector froth.

Pre-Labor Day Weekend Coming Up

As we’ve elucidated repeatedly, the cannabis market—in its current iteration—is almost exclusive news-driven on a macro level. That will change of course, in the coming quarters as the market gradually shifts towards revenues/earnings discount metrics. If this wasn’t entirely clear, the Canopy Growth-Constellation Brands equity integration certainly cleared that up. Has anyone talked about WEED’s quarterly earnings, released concurrently to the deal?

Belying the fireworks we’ve seen lately, I believe there’s a good chance the news cycle will be relatively tame next week. Traditionally, the last week of August is one of the market’s quietest periods, as investors take extra days off to extend vacation times. In Canada, many people consider the Labor Day long weekend as the “unofficial” end of summer, and generally take advantage of the great weather by doing things other than work. That’s a generality of course, but a truism nonetheless.

While the lack of activity could theoretically limit downside activity as well, at these levels, the onus is on bulls to maintain momentum—not the other way around. It will be a tough task to keep prices marching higher—or even remain at a standstill—if both volume and news can’t remain in hyperdrive.

Final Thoughts

Again, I don’t expect this article to win any popularity contests. Shareholders and insiders are making money, and few investors want to see this cannabis sector bull run come to an end. This projection may be slightly ahead of its time, as most technicals remain in resolutely-bullish territory. If this is the long-awaited industry consolidation moment everybody has been waiting for, who knows how much price extension remains.

But for the reasons mentioned above, I believe sector consolidation is likely on the doorstep. With record (or near-record) on-open buying in both Canopy Growth and Cronos Group—right at (or near) overbought levels—the next FOMO is likely nearing the profit-taking side of the equation. We also saw Aphria smash its all-time volume high (23.1 million shares!) on news that was already semi-known on Bay St. Both of these scenarios reek of near-peak FOMO, although there may be cause for Aphria to rally further.

The Midas Letter congratulates all investors who profited from this historic cannabis sector run—wherever it may end. Barring an imminent major Canadian LP purchase by Big Alcohol, I believe the pause button will be pressed early next week. For a market in serious need of consolidation, that’s a positive development.