Playing Corn’s Pop
Featuring John Roque
Published on: May 30th, 2019 • Duration: 13 minutesJohn Roque, CMT, of Wolfe Research discusses his bullish thesis on a high-flying commodity: Corn. He breaks down the historical chart patterns, examines the recent price spike, and reviews how to play the situation. He also recommends a second trade idea with a bearish bet on the Russell 2000, in this interview with Jake Merl. Filmed on May 29, 2019.
JAKE MERL: Welcome to Trade Ideas. I'm Jake Merl, sitting down with John Roque of Wolfe Research. John, great to have you back on the show.
JOHN ROQUE: Thanks for having me, Jake.
JAKE MERL: So, you were last here a couple months ago, going long Chinese stocks. The trade is working out pretty well up almost 10% in just a few weeks. And then it's sold off as Trump and the trade war rhetoric queued up in April. Chinese equities that ended their decline at that 2850 level, which is actually your initial stop loss. Do you have an update for this trade, John? Are you still interested in it at all?
JOHN ROQUE: I am still interested in it. But I'm going to say that I'm going to be aside now until these geopolitical tensions ameliorate. So, I'm going to pull aside mostly because A, they didn't hold up better. And the rest of region is pretty darn weak in addition, so I'm going to wait until there's more clarity.
JAKE MERL: Gotcha. Thanks for that update, John.
JOHN ROQUE: You got it.
JAKE MERL: And so, shifting gears to today's trade ideas, I believe you have two in mind. The first trade, you're going long corn.
JOHN ROQUE: That's right.
JAKE MERL: And the second trade, you have a bearish trade idea on the Russell 2000. But before we get into those two ideas, can you just please briefly review your technical approach to markets?
JOHN ROQUE: Sure. I'm a trend follower. I believe price is the raison d'etre for why we're in this business, everybody gets mark to market on price. You could get all of your fundamentals right, but the price wrong and you don't get paid at the end of the year. Similarly, you can have a great economic view. But if you can't turn it into price dollars, or how you're going to be measure it on a mark to market basis, it really isn't that important. So, we really are price focused, trend focused, and we score everything that has a price on a zero to four scale. And using that scale, threes and fours, we generally want to be buyers of and zeros and ones, we want to be sellers or shorters of, that's how we end up coming up with our opinions.
JAKE MERL: And so, today, you're looking at corn. Corn has recently been getting a lot of attention. We've seen this significant spike higher over the past few weeks. What specifically are you looking at, John, that suggests corn is going to head even higher from here?
JOHN ROQUE: Okay. So, Jake, I want to be straight up with you. I actually thought of this as a long idea in December, January and February. And corn had set up fairly nicely, and then it declined really sharply until about 11 or 12 days ago. So, I don't want to say that this isn't a fraught with some tension here. Because I had it set up and then it failed. And it's come back.
So, what I did in order to set up for this idea was I went back over corn's history, going back to 1970. And I just studied each of the prior 10 bear markets for corn, and each of the prior nine bull markets for corn, right? We are just entering the 10th bull market. And I figured out how long each bull market had lasted time wise. And I figured out what we had gotten in terms of average, minimum, maximum and the median advance. And I realized corn is up a lot over the last two weeks or so. And it's right back into the 2016 high.
But based on the historical work that I've done, it looks like this has some legs to it. So, I think if people are long corn, they should try to continue to roll out their long positions. And if they're not, I think that on pullbacks or consolidations, because it is pretty overbought here on a short-term basis, it's a good spot to add.
JAKE MERL: So, you wouldn't be buying at current levels given this recent spike higher? You actually think it's going to go down a little bit and that would be a better entry?
JOHN ROQUE: This is a very difficult situation because it could continue up from here. The likelihood is that it probably will not. So, it's sprinted a long way in a short period of time. And like any other thing that sprints, most humans in particular, you need to rest after you've sprinted and run a long way in a short period of time. So, I think corn needs to rest. Perhaps it does that by just working sideways. Perhaps it does it by just pulling in a little bit. But we think that there's still a bigger move to the upside based on the historical work we've done.
JAKE MERL: And so, why specifically, are you bullish on corn? What were you looking at in January and December that had you so bullish?
JOHN ROQUE: Okay. So, as I mentioned, corn have gone through 10 bear markets. And I studied what the length of those bear markets were. And I compared the current one, which should not, which had pretty much ended actually, a few years ago. And I said this is just about as bad as it gets. How much worse can it get for corn? No, I'm not a corn analyst. So, I tend to weigh that question. And I say, it probably can't get very much worse for corn.
So, I started to look at it and just say to myself is it going to turn? What's going to be needed for it to turn? What's going to be needed? And again, I thought it had set itself up in December, January and February, only to come in into May- let's say a few weeks ago. And it was only because I had done a historical work to set up for the trade. Now, to tell you the truth, I'm still waiting for soy and wheat to participate as corn has participated, because grains tend to move together. So, corn is out ahead. And I keep, it's on the docket, to pay attention to wheat and soy as well.
JAKE MERL: So, if you look at a five-year chart, John, it looks like this morning, we just hit those prior peaks around 435, 440. And then it immediately sold off harder on 5% or so. Are you worried about that resistance at all?
JOHN ROQUE: I am in light of the fact that we're up a lot in a short period of time. But I think that corn has built a big enough base that any pullback is going to be light, well-contained and provide the next spot for it to work higher above those 2016 levels.
JAKE MERL: So, how specifically would you go about trading it? I know you said you won't go into current levels. But what's your target price on the upside and do you have a stop loss just in case things don't go your way?
JOHN ROQUE: Well, it doesn't seem to me to be a great call from here based on historical to see you get back up to the $6-bushel level, which I think is pretty doable. So, if we could get that from here. So, let's say you have a downside, perhaps maybe of 10%, just because you don't want to keep averaging in losing positions, I think that'll be reasonable.
JAKE MERL: And over what time horizon do you expect this to play out?
JOHN ROQUE: If I'm going to go through some of the numbers here just to give you an idea, the average time of corn's bull market is about 20 months, the median advance of corn in a bull market is 17 months, the maximum advance that I studied was 40 months. And the smallest length of time for corn's advanced was 11 months. Over those time frames, the average percentage gain was 120%, the median gain was 135%, the maximum gain was nearly 170. And the minimum gain was 52%. And we even extrapolate the smallest gain over these prior bull markets, we would get almost another 25% or so move from here.
JAKE MERL: And so, John, what would you say is the biggest risk to this trade?
JOHN ROQUE: Wow. It could be like a situation with China where the historical sets it up properly, and you get some outside event that pulls it in and compromises the trade. But I think it may be too hard to figure that out. And it may be just easy to use a good stop loss. That way, you're out and you don't have to rationalize your losses.
JAKE MERL: And so, before, you actually mentioned some other commodities such as wheat and grains, are you looking to trade those as well?
JOHN ROQUE: Not yet. I'll tell you which one was that we do have a strong call on and that's oil. And we think oil works a lot lower from here. We did some historical studies for oil, not to the degree that we did for corn. But we found that it was almost impossible for oil to be in a bull market when the rest of the commodity complex and the commodity complex is still in a poor market, except for corn, which has had a big move here. So, the commodity complex has been disappointing, whereby the energy complex had had a big move despite that. So, we thought that oil was a sale, we still think it's a sale. And we think it's going to work lower. And our near-term target's $50 on the downside.
JAKE MERL: So, I know we went through a lot of your bread and butter for this trade. But are there any other indicators? Any other tools? Any other markets out there that's confirming your thesis on corn?
JOHN ROQUE: No, I'd say that this is a- I don't want to call it a one off. But it is very particular. Because the rest of the commodity markets represented by the items inside the CRB don't show this activity. So, it I wouldn't say this is a broad base advance, it's clearly not. And especially if we think oil is coming in which we do, it's just a special situation item for corn in particular, and wheat and soy have not yet shown themselves to do what corn has done.
JAKE MERL: And so, moving on to your second trade idea for today, you're shorting the Russell 2000. So, what specifically are you looking at there?
JOHN ROQUE: Well, for a few reasons. Number one is about 35% of the stocks in the Russell 2000 don't make money. Number two is if you took the entire market cap of the Russell 2000, it's about $2.3 trillion. The first three stocks in the S&P 500 on a market cap basis, which are Microsoft, Amazon and Apple, that's $2.6 trillion. So, really, the cap size of small cap is really very small when it comes down to it. I don't think that there's anybody out there, at least in my opinion, who's going to sell any of those stocks to buy small cap stocks. There's not enough cap to keep anybody happy in small cap.
And in addition, while the Russell 2000 had a big move off of the low in December, it actually outperformed the S&P on that first move up. The Russell did nothing since February. So, it has been a relative underperformer. In addition, now, number four, it's actually leading on the downside. It has broken or compromised support levels before the S&P has. So, we think there's more room on the downside for the Russell 2000.
And then lastly for that, because of that cap restriction that I mentioned- the cap scenario. If the Russell does outperform, we've thought for a long time and it is merely an IWM outperforming trade rather than small caps outperforming. I know that may be a distinction without a difference but it's easy to buy the IWM and deploy some market cap or assets under management. It's very hard to deploy them in small cap stocks because there's not enough cap to go around.
JAKE MERL: So, John, why not short one of these high- flying areas the market like tech, why are you specifically focusing on small caps?
JOHN ROQUE: Okay, so the way we tend to think about it is we would rather short weakness than short strength. Over time, we'd rather buy strength instead of buying weakness. And so, the weak stocks are weak or the weak indexes are weak for a reason. We think they're weak for fundamental reasons. We just think that we're identifying it for our technical reasons. So, that's why we want to short the weaker items rather than the stronger items.
JAKE MERL: And so, what key levels are you looking at here? How exactly would you go about making this trade?
JOHN ROQUE: So, we think it's okay to put it on right here. And unless the Russell 2000 gets above where it was, let's say earlier this month or in April, we think you stick with a trade. And we think it has risk to about $1350, which would be down another 12% or so from here, which would take it down 20% from its most recent high.
JAKE MERL: And over what time horizon do you expect it to play out?
JOHN ROQUE: Wow, given the way markets behave here, it might be sooner rather than later. It wouldn't surprise me if it played out through the end of the summer.
JAKE MERL: And what would you say is the biggest risk to this trade?
JOHN ROQUE: Well, I'm no geopolitical analyst, but I'd say if there's some reduction intentions between the US and China with respect to trade, I'm going to leave that to others, though, I'd say that markets are likely to have a sharp rally. But I wonder if because everybody's anticipating that to occur, if it would be a rally to sell or the rally that would fail, but I think that would be something that we'd have to pay attention to.
JAKE MERL: John, that was great. Thanks so much for joining us.
JOHN ROQUE: Thanks for having me, Jake. Appreciate it.
JAKE MERL: So, John is bullish on corn. Specifically, he suggests buying it at current levels or on any small pullback. He has a 10% stop loss and thinks it could reach $6 over the next year. In addition, John is bearish on the Russell 2000. He suggests shorting it at current levels with the stop loss at $1615 and a target price of $1350, over the next three months.
That was John Roque of Wolfe Research and for Real Vision, I'm Jake Merl.