A Canadian mutual fund manager who specializes in marijuana stocks has some advice for investors; brace yourselves for some more "scary down days," according to Bloomberg

“I wouldn’t be surprised if we saw a steep, sharp pullback, which will scare all the people that got in late, have a little bit of consolidation and then we start the next phase up,” said Bruce Campbell, founder of StoneCastle Investment Management Inc., which has about C$150 million ($115 million) in assets.

On Friday, the Kelowna, BC based firm will launch the StoneCastle Cannabis Growth Fund along with Toronto-based Spartan Fund Management Inc., a month before Canada legalizes recreational marijuana. 

The actively managed momentum fund will use technical analysis to invest in cultivators, along with ancillary businesses such as delivery and testing services, retailers and real estate. 

Cannabis stocks have been red hot since mid-August, when Canopy Growth Corp. announced a C$5 billion investment from Constellation Brands Inc., the biggest deal in the sector to date. The BI Canada Cannabis Competitive Peers index has added nearly 50 percent since then, while other stocks have posted even more outsized gains. Tilray Inc. has soared more than 600 percent since its July IPO. The stock rallied as much as 21 percent in New York Thursday, pushing its market value past $10 billion. It has added about $4 billion since Friday’s close alone. -Bloomberg

What does Campbell like? Smaller companies which haven't risen as much as their peers, with a mixture of Canadian and US exposure. The new fund's holdings will include: Valens Groworks Corp., Sunniva Inc., C21 Investments Inc., CannTrust Holdings Inc. and Organigram Holdings Inc.

Don't trip though, despite some valuations being "off the carts," Campbell also says that there will be companies that can do "phenomenally well." 

“You’ve got to watch that valuation, you’ve got to figure out what’s reasonable and then continue to track it over time and see whether they’re actually proving that they’re working towards those goals or is it sort of a pie-in-the sky dream?” he said. “Because there will be a day when the market wakes up and says, ‘Whoa, hold on. We’re paying way too much for this’ and the sector all goes down and some of it will never recover.”

Chris Woods at Grizzle.com noted some of the headwinds facing pot stocks in April: 

1. Legalization of marijuana always equals price deflation – In every legal market, retail and wholesale prices peak near the date of legalization due to lack of supply and then quickly begin to fall, driven down by new entrants.

2.  The black market is the biggest competitor for licensed producers – The marijuana market is mature in Canada with the black-market supply already exceeding demand (Canada exported 20% of marijuana production in 2017). Legal supply will have to compete on a price basis for market share — the black market won’t magically disappear.

3.  Extreme valuations are reminiscent of the 2010 rare earth bubble. The bulls want to believe marijuana is a manufactured and branded product. It’s not. Marijuana is a commodity and always will be (see Colorado, Washington, and California).

MARKET WILL BE FLOODED WITH PLANNED LEGAL CAPACITY – 2X DEMAND

Grizzle compiled the planned capacity of the top 13 legal producers in Canada. Based on estimated consumption rates, Canada will be at least 850,000 kg (85%) over supplied by the end of 2021. Importantly this oversupply doesn’t account for smaller producers or the black market, which is already fully supplying the market.

As Woods concluded: With no valuation support, marginal management teams, and a skittish retail investor base — the outlook for marijuana equities is bleak.