Testing for Mild Explosivity and Bubbles in LME Non‐Ferrous Metals Prices

Abstract

This paper applies the mildly explosive/multiple bubbles testing methodology developed by Phillips, Shi and Yu (2015a, International Economic Review, forthcoming) to examine the recent time series behaviour of the main six London Metal Exchange (LME) non-ferrous metals prices. We detect periods of mild explosivity in the cash and three-month futures price series in each of copper, nickel, lead, zinc and tin, but not in aluminium. We argue that convenience yield, though the formal counterpart to dividend yield in commodity markets, is not a useful basis on which to assess whether observed explosivity is indicative of bubbles (namely, departures of prices from their fundamental values). We construct other measures that provide evidence that suggests the observed explosivity in the non-ferrous metals market can be associated with tight physical markets.

The shine of precious metals around the global financial crisis

“…This might suggest that, if unity really were the appropriate value for the tuning parameter for monthly data, we should use a higher value for weekly data. The optimal choice of tuning parameter (on the basis of sampling frequency) is currently the subject of ongoing work by the second author; here we simply follow Figuerola-Ferretti et al (2015) and confer some robustness on our approach by reporting results using higher values of the tuning parameter alongside unity.…”

“…Convenience yield may be interpreted as the premium stockholders will pay for immediate access to inventory of known specification and location. Figuerola-Ferretti et al (2015) The final column of Table 1A reports the GSADF statistics for the four convenience yield series. All four statistics are negative, and so the null hypothesis of no mildly explosive period is not rejected.…”

“…Specifically, the ratio of the NASDAQ index and dividend yield on the basis of monthly data was used to test whether there was a non-fundamentals-based departure from trend in the form of explosivity in NASDAQ stock prices. As Figuerola-Ferretti et al (2015) explain, this procedure is impractical to apply to commodities because the ratio of commodity prices and the natural counterpart to dividend yield -convenience yield -becomes uninformative when the convenience yield approaches zero, which it can do for perfectly natural reasons. We demonstrate that this same problem affects precious metals, where the measured convenience yield can be low or even negatively valued, making the ratio between the commodity price and measured convenience yield uninterpretable.…”

“…Figuerola-Ferretti et al (2015) offered a context, however, in which inelastic mine supply combined with fluctuating demand saw departures in non-ferrous metals prices from the random walk with drift model that could be explained by a standard stock-to-use-ratio fundamental. We prefer, therefore, to follow the PSY approach to bubbles, in terms of their representing departure from fundamental value.…”

Tests for explosive financial bubbles in the presence of non-stationary volatility

“…Figuerola-Ferretti et al (2015) have, however, cast doubt on the e¢ cacy of using an imputed convenience yield as a fundamentals proxy variable to support running a bubbles test on the ratio of the raw prices and this imputed value, and in this exercise we simply report results using just the real and nominal series themselves. metals, …nding evidence for multiple periods of explosive behaviour during the 2000s in …ve out of the six metals considered.…”