London Metals Exchange data & backtesting

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ecritt
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London Metals Exchange data & backtesting

Post by ecritt » Thu Mar 11, 2010 6:44 pm

I've been studying the LME contracts for a couple of months now. I'm convinced that backtesting on the LME data that comes out of CSI (or any other data source I've seen) is not realistic. The data are price quotes for a new 3 month forward. The day after you purchase a forward contract it ceases to be a 3 month forward. With each passing day its term to maturity shrinks, and ultimately converges with the cash market. But the only data you have for backtesting purposes are the quoted prices, each day, for a NEW 3 month forward.

During periods of extreme and/or persistent contango or backwardation, relying on the quoted prices of a new 3 month forward can result in dramatic errors in profit/loss estimates.

To illustrate this I use data for LME Copper 3 month forwards and LME Copper cash to create a synthetic equity curve representing 1 contract rolled every 3 months from 1968 to current. At the beginning of January I assume purchase of a 3 month forward at its quoted price. At the end of March I assume liquidation at the quoted cash market rate (futures price converges to spot price at expiration). Then I repeat, purchasing a 3 month forward contract and and again liquidating 3 months later at the cash market rate, so on an so forth. As you can see in the attached chart, most of the time the synthetic equity curve closely tracks the quoted prices for LME Copper, both 3 month forwards and cash. However, there was a rather nasty 90% drawdown during the 1980's that only shows up if you actually roll the position; it does not show up in the quoted prices for 3 month fowards or cash. Evidently the contango during that period of time was both persistent and extreme.

Any thoughts on how to properly backtest LME data? Or am I just wrong about this?
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sluggo
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Post by sluggo » Thu Mar 11, 2010 7:48 pm

You can trade whichever prompt dates you like (I happen to prefer the 3rd Wednesday of the month) and you can roll them whenever you like.

One thing you could do, if you wished, is to initiate new a position in a prompt date 4 months away. When a month passes (making it now a 3 month forward), roll it to a 4 month forward. Thus your forward varies between 4 months and 3 months.

Or if 12 rolls per year is not your cup of tea, initiate in a 4 month forward, hold for 2 months, then roll. Wallah, 6 rolls per year.

The paperback book on the LME's website is fairly good: https://secure.lme.com/Shop/product.aspx?id=478

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Post by AFJ Garner » Fri Mar 12, 2010 3:25 am

A brief look at the cash (spot) charts and back adjusted charts of Comex Copper confirms the point. As regards copper, you have the luxury of using the Comex futures contract and can back test it accordingly. Not so with Zinc and the other base metals.

Sluggo is of course correct - you can roll when you like and rolling a 4 month forward after 3 months will undoubtedly have an effect (of some sort) on contango/backwardation. Testing would no doubt establish which rolling method would (in the past) have minimized contango.

But ecritt' stark and realistic point remains - any back test is highly misleading unless you create a new price series reflecting the actual rolling method you want to test. I have long been uneasy about the situation and have pointed out elsewhere that contango has in the past severely diminished returns from commodities such as gold and wheat held through futures contracts (and of course this is the only method of exposure possible for long term holding of perishable commodities such as wheat).

Thus far I have not bothered to create the necessary data series. But ecritt is 100% correct - it needs to be done. Thank you for prodding us into action!

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Post by LeviF » Fri Mar 12, 2010 10:06 am

Are there some physicals that are more sensitive to current interest rates than others?

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Post by LeviF » Fri Mar 12, 2010 1:03 pm

AFJ Garner wrote:...any back test is highly misleading unless you create a new price series reflecting the actual rolling method you want to test. I have long been uneasy about the situation and have pointed out elsewhere that contango has in the past severely diminished returns from commodities such as gold and wheat held through futures contracts (and of course this is the only method of exposure possible for long term holding of perishable commodities such as wheat).
I see the issue with using LME data as noted by ecritt, but for this comment by AFJG, isnt that the whole point of getting backadjusted data?

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Post by RedRock » Fri Mar 12, 2010 1:26 pm

The LME is unique as when you trade, they write a contract 'just for you' with a prompt date x days out. This individual date contract will not match the standard 3 mo rolling contract CSI provides. LME is not the best place to begin trading forwards/futures...

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Post by AFJ Garner » Fri Mar 12, 2010 4:24 pm

Levi wrote: Isn't that the whole point of getting backadjusted data?
Yep: but as Eric points out, in the case of LME data you must do your own back adjusting!

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Post by LeviF » Fri Mar 12, 2010 4:28 pm

Why did you mention gold & wheat?

Forgive me, my knowledge on the mechanics of futures contracts is pretty limited...

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Post by AFJ Garner » Fri Mar 12, 2010 4:37 pm

Because as with COMEX copper, they are normal futures contracts, often in contango, and by comparing the spot chart with the back adjusted chart you can see the effect of contango in the same way as you can with Eric's charts above. Without constructing the synthetic 3 month contract (putting LME metals onto the same basis as normal futures contracts) you are unable to see the effect of contango by looking at the rolling 3 month forward data.

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Post by ecritt » Fri Mar 12, 2010 4:41 pm

Levi wrote:Why did you mention gold & wheat?

Forgive me, my knowledge on the mechanics of futures contracts is pretty limited...
See attached chart of gold during the 1980's and 1990's.

((( EDIT: The pink line below is incorrect. Thanks to Jez Liberty for uncovering my programming logic error. A valid version of the pink line would not be materially different from the standard back adjusted contract. )))
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Last edited by ecritt on Mon May 31, 2010 7:08 pm, edited 2 times in total.

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Post by ecritt » Fri Mar 12, 2010 4:46 pm

AFJ Garner wrote:Because as with COMEX copper, they are normal futures contracts, often in contango, and by comparing the spot chart with the back adjusted chart you can see the effect of contango in the same way as you can with Eric's charts above. Without constructing the synthetic 3 month contract (putting LME metals onto the same basis as normal futures contracts) you are unable to see the effect of contango by looking at the rolling 3 month forward data.
Here was my first crude attempt to create a synthetic of LME Copper. Notice it is quite similar to COMEX Copper.
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Post by ecritt » Fri Mar 12, 2010 5:13 pm

sluggo wrote:You can trade whichever prompt dates you like (I happen to prefer the 3rd Wednesday of the month) and you can roll them whenever you like.

One thing you could do, if you wished, is to initiate new a position in a prompt date 4 months away. When a month passes (making it now a 3 month forward), roll it to a 4 month forward. Thus your forward varies between 4 months and 3 months.

Or if 12 rolls per year is not your cup of tea, initiate in a 4 month forward, hold for 2 months, then roll. Wallah, 6 rolls per year.

The paperback book on the LME's website is fairly good: https://secure.lme.com/Shop/product.aspx?id=478
Yes, this is very similar to what a couple of CTA's have told me. The problem is creating a time series for backtesting...and for generating signals in real time. Working on that now. Thanks for the book link; I've been looking for just such a thing. I also purchased "Wolff's Guide to the LME"; facinating read so far.

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Post by AFJ Garner » Fri Mar 12, 2010 5:41 pm

ecritt wrote: The problem is creating a time series for backtesting...and for generating signals in real time.
Yes. Prior to running one's system each day to generate signals, there will be the extra step of generating updated synthetics for the day. Oh dear me, I can see I am going to have to do some work.

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Post by LeviF » Fri Mar 12, 2010 7:55 pm

I use Blox for tasks similar to this. I have a simulation suite that i run that manipulates the data each day, then i run my order gen suite after that.

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Post by Moto moto » Sat Mar 13, 2010 5:16 am

"Oh dear me, I can see I am going to have to do some work."

One of the best lines I have read on any trading forum ever. thanks.

(interesting discussion none the less - the difference between reality and fantasy for many systems that seem to fail in the real world most likely lies in the quality of the data in the back test?)

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Ebullio Hedge Fund loses 86% in one month on LME metals...

Post by LeapFrog » Tue Mar 16, 2010 12:32 pm

http://www.businessweek.com/news/2010-0 ... ate1-.html

Looks like these guys got squeezed big time.

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