Good Friday. Here is today’s memo:

Today | 4 items


1. How to invest in cannabis (reader question)

Important

This is a new and developing market. If you are going to put money at risk it needs to be money you can afford to lose.

In addition, you need to have a 10 year+ time frame. If the upside in this industry is as large as people think it is, it will take time to develop and grow.

One thing to keep in mind.

In the U.S., while cannabis is legal in a handful of states, it’s still illegal at the federal level. Some banks and brokerages won’t take the legal and reputational risk of holding stocks that are illegal at the federal level.

Most of the investment products available for retail investors are based out of Canada and trade on their TSX exchange. Recreational marijuana will be legal in Canada sometime this fall, possibly August or September.

I am still new to this space and don’t have any insights yet. I will report what I am reading and a few investment options for you to look at.

ETFs

The largest ETF in this space is ETFMG Alternative Harvest ETF (ticker MJ) with $300 million + in AUM. You can buy this ETF at most U.S. brokerages.

The management fee is 0.75% or 75 basis points. For every $100 invested, you pay 75 cents.

Here are the top 10 holdings:

This index tracks the Prime Alternative Harvest Index; which launched in December 2017.

Here is a summary:

“The Prime Alternative Harvest Index has been created to provide investors with a product that enables them to take advantage of both event-driven news and long-term trends in the cannabis industry as well as the industries likely to be influenced by the medicinal and recreational cannabis legalization initiatives taking place in many locations globally.”

Like I said, I will have to do more digging. As with any new industry, there is a hype cycle followed by a trough of disillusionment(when you want to buy). See below.

The value chain

Let’s take a look at the value chain. Remember, value chains track the flow of money through an industry. If there is a choice in whom you pay, you usually pay less, if there is only one choice or if switching costs are high, you usually pay more.

What you’re looking for in a value chain is a business that’s a chokepoint. Meaning, a critical piece that other companies rely on in which there isn’t another good option outside that company.

For example, in the 90’s, computer manufactures had no choice but to include Microsoft windows on their computers, otherwise, they couldn’t sell them.

It’s too early to see where the chokepoints will be but it’s something to keep in mind as you look at potential investments in this space.

Canada

I was curious…

Canada is expected to legalize recreational marijuana in August of this year. Each province is responsible for their own laws around marijuana use.

Toronto is Canada’s largest city, located in the Ontario province; here are the laws they set out regarding the use and sale of marijuana:

  • Age of legal consumption-19+
  • Where to buy-Government-operated storefronts and online sales.
  • Grow your own-Up to four plants.
  • Where to smoke-Private property, subject to landlord restrictions.
  • Other notes-40 cannabis stores will be open by July 2018, 80 by 2019, and 150 by 2020.

To end…

Even though growers are the main public companies, they don’t interest me as much as retail stores that will own the relationship with the end user. I sense there will be a McDonalds and Chipotle of the marijuana sector. A couple of companies that will attain brand recognition across the country and create a standardized product that is same across stores; like the Big Mac.

Just something to think about…


2. Want to bet on a long-shot?

I love going to the movies.

For $10/month you can see as many as you like with MoviePass.

Only one problem; the business is losing money, fast, and many doubt its viability as a going concern.

It’s quite amazing.

MoviePass pays theaters full price for every movie ticket. The average ticket costs $9.16 in the U.S. They are losing money if their customers go to more than one per month; which they do, that’s why they signed up in the first place.

Their parent company is Helios & Matheson analytics Inc(HMNY)

My thought bubble…

I think I’ll pass on this one:)


3. ETF investors still love gold

But while the bullion price in the futures market on Tuesday reached a new low for the year, exchange-traded-fund investors recently have been bullish on gold. Investors poured about $3.1 billion into gold-backed ETFs during April, the highest total since February 2017, data from the World Gold Council, an industry trade group, showed reports the WSJ.

I don’t know who’s buying; retail investors, hedge funds, or institutions?

However, hedge funds and large speculators have slashed their net bets on higher gold prices.

My thought bubble…

Full disclosure.

I am long gold via the ETF GLD. Not because of any fundamental reason, but because of order flow.

Let me explain.

Price often moves before the fundamental picture becomes clear. My goal is to get my clients on the right side of the order flow and find attractive bets with favorable risk/reward profiles.

Let’s look at the chart. (click to enlarge)

GLD chart

GLD chart

Let’s run the numbers

Entered position at $116.

I will exit this position with a weekly close under $114.

My initial target is $150.

To calculate the reward-risk, you take the (reward−entry price)÷(entry price − stop)

(150-116)÷(116-114) = 17

Meaning I get paid $17 dollars for every $1 dollar I risk.

But, but, but…

We must also calculate the probability of the trade working out. Since we won’t know the exact probabilities, we have to come up with reasonable estimates.

This is called Expected Value.

The equation is:

(probability of winning × amount won) − (probability of losing × amount lost).

For example:

In the example above, I put the probability of winning at 25% and the expected value still came out positive seven(7). Meaning if I took this trade over and over, I could expect to make $7 dollars on average.

How come?

Magnitude. It’s the magnitude that counts, not how many you get right. It’s slugging percentage vs batting average.

Let’s see what happens when I bump the amount won down to 5.

Now we lose 25 cents on average because the magnitude of our win does not offset the greater probability(-75%) of the loss.

The greater point is to learn to think in probabilities, not absolutes.


4. The bottom 40%

At a time of rock-bottom joblessness, high corporate profits and a booming stock market, more than 40% of U.S. households cannot pay the basics of a middle-class lifestyle — rent, transportation, childcare and a cellphone, according to a new study. Per Axios

ALICE is an acronym that stands for Asset Limited, Income Constrained, Employed.

In other words, it’s people above the federal poverty level but below the basic cost of living.

The study was conducted by United Way. Based on their data there are 34.7 million households in this group.


Thanks for reading and have a great weekend,

Caleb

Category:
Pure Alpha

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