Wednesday, May 02, 2007

Are claims of seasonality in commodity futures markets "fraudulent "?

I have written about several commodities futures seasonal trades (e.g. PL-GC here, and RT here) recently, and while I was researching another such trade I came upon this webpage from the Commodity Futures Trading Commission. It says, in no uncertain terms,

" The Commodity Futures Trading Commission (CFTC) warns consumers to be alert to possible fraudulent claims that they can profit on commodity futures or options trading as a result of changes in the prices of physical commodities based on seasonal weather patterns or other well-known events."

It goes on to say that

"Futures and options markets adjust very quickly to news events and announcements, and by the time salesmen come calling, the opportunity to profit from such news is gone."

Whoa, this certainly got my attention! Since I am not a journalist, I don't normally go around challenging claims made by the United States government. But if this statement, which is basically the efficient market hypothesis, is generally true, then all of us traders should just pack up and go home. Now whether or not the efficient market hypothesis is true is subject to much academic debate. But is it right for the government to state definitively that this hypothesis is true, and that all claims otherwise are "fraudulent"?

Political arguments aside, I think that the commodities market may have more arbitrage opportunities (i.e. less efficient) than the stock market. Perhaps this is because there are more participants in the commodities markets that are not speculators, particularly for "consumption" commodities such as oil and gas.

This is not to say that every seasonal pattern that we have backtested is necessarily going to repeat itself. Many of these patterns occur only once a year, and there are just so many years that we can use for our backtest, and needless to say, most of them are "in-sample". My practice is to paper-trade the pattern for at least one year going forward as an "out-of-sample" test, especially if the pattern is not supported by a strong fundamental rationale (like the Australian dollar trade that I talked about in my premium content area.) Furthermore, by publishing my backtest results on this blog, any future repeat of the pattern can indeed be regarded as out-of-sample, increasing our confidence in them.

My own interest in researching seasonality in commodities market was (hopefully) not piqued by the kind of snake-oil salesman that CFTC warns us about. About a year or so ago, I attended a talk given by Dr. David Eliezer at Columbia University's Financial Engineering seminar. The topic is "Structure and Behavior of Commodities Markets" in which he outlined various seasonal patterns that persist in the futures markets. Dr. Eliezer was formerly the chief quantitative researcher at Goldman Sachs' commodities group. Given this academic respectability, I certainly feel emboldened to enter into the debate!