MSOS - MSOS: Character Change In Cannabis Sector (Technical Analysis)

2023-09-14 03:17:40 ET

Summary

• The cannabis sector is seeing record high trading volumes on the back of news that the drug may be reclassified. Price action suggests a significant character change in the sector.
• Institutional money is likely driving the move higher, with the MSOS ETF now trading above its key moving averages for the first time since March 2021.
• Stocks thrive on momentum and a "thematic story" (e.g. AI stocks in 2023). MSOS ETF is down close to -85% from its all-time highs, and there is huge upside potential.
• MSOS is near-term extended after its huge run up. I am waiting for its first pullback to its moving averages, where I will assess how price reacts there.

The market has been weak for the past few weeks, but there is always a silver lining. It is easier to spot relative strength in a specific stock or sector when the market is weak, than when the market is strong.

One sector that caught my eye is the cannabis sector.

There was a catalyst in late August, when the Department of Health and Human Services asked the Drug Enforcement Agency to consider reclassifying cannabis .

The catalyst led to sustained record high trading volumes in the Pure US Cannabis ETF ( MSOS ) for two weeks running, and there is a strong likelihood that institutional money is flowing into the sector. This price reaction is a significant character change in the sector ETF. With the ETF trading close to -85% below all-time highs, the risk-reward is attractive to be long MSOS.

Cannabis is currently listed alongside Heroin and LSD as Schedule I drugs, and a reclassification lower would potentially provide many benefits for the cannabis sector, including tax benefits, interstate commerce, and research opportunities.

More important than the catalyst itself is the price reaction to the catalyst. If we get a strong, positive reaction from the market, this tells us that the market is buying into this news.

And that is exactly what we got.

The MSOS ETF is the cannabis ETF with the highest AUM at $620m. Its average daily volume is the highest in the space at 4.5m shares traded per day, or about $40m in daily dollar traded volume at current prices.

The ETF is an actively-managed US-listed ETF with dedicated cannabis exposure, and aims to invest in US cannabis companies. Many of these companies are primarily listed in Canada, which may only be available to some investors via the US OTC market (like myself). As such, this ETF provides accessible exposure to these stocks.

Diving into the technical charts, we may see from the weekly chart below that the ETF saw record volumes for the weeks of 28 Aug and 5 Sep.

Weekly Chart: MSOS

This is a strong signal that the market believes something has significantly changed in the sector. The cannabis sector had previously seen many instances where stocks jump on optimism that there could be further legalisation of the drug, before seeing these gains wiped out when there is no end product.

Is this time different? Only time will tell, but the manner in which the volume is coming in sharply, at more than twice the previous weekly record high volume in Dec 2022, tells me the character of the sector has changed.

This high volume has so far been sustained for two weeks, and a big clue on whether institutional money is coming in would be whether the volume stays elevated on up-weeks, and whether the volume stays low on down-weeks. This would indicate that there is not much supply in the market, and buyers are not selling their shares.

This is also the first time MSOS is trading above its 10 and 20 week moving averages since Mar 2021, which is another green flag.

The risk is of course, that cannabis fails to get reclassified. However, as the saying goes "Buy the rumour, sell the news". This "rumour" is attracting huge inflows. Furthermore, stocks thrive on momentum and a "thematic story". In the same vein, many AI stocks are not profitable but have put in huge returns this year.

From here, I think MSOS is extended in the near term after rising +75% in 9 sessions. A better opportunity would be to wait for its first pullback to the moving averages. I want to wait for the 10 and 20 day moving averages to catch up, and for there to be some consolidation at those averages, before I buy in.

Daily Chart: MSOS

To sum up, MSOS has seen record volumes recently due to a potential reclassification of cannabis. The high volumes, coupled with the fact that price is now above key moving averages, tells me this is likely a character change in the sector. There is a strong likelihood of institutional money entering the sector.

MSOS is near-term extended after its huge run up, and I would prefer to wait for its first pullback, and watch for how price reacts near its 10 and 20 day moving averages. If volumes remain low on down-days, it tells me supply is drying up, which is constructive for the sector.

MSOS ETF is down close to -85% from its all-time highs back in 2021, so there is plenty of room for this ETF to run. Furthermore, the fact that it is trading above key moving averages on both the daily and weekly charts means there is little overhead resistance.

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