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How Charts Lie

How Charts Lie

It’s too hard to find good market analysis, and far too easy to find bad analysis.

There’s really a LOT of bad analysis out there. It’s hard to avoid if you aren’t wary of your sources.

It doesn’t take all that much to get an article published on Seeking Alpha. It takes even less to post a YouTube video — or, God forbid, a TikTok. Most often, these sources are more interested in pumping their own positions than they are publishing sound ideas.

That’s why I only read reports from reputable sources — namely exchanges, money managers, institutions, and hedge funds. These almost always contain great data and studies on the market. Ideas worth trading.

But recently, I read something from the CME Group — the futures and options exchange — that proved even the most reputable sources are vulnerable to deception.

If you happened to see this chart, it might’ve urged you to make a radical investment decision. One which, in my opinion, would be a mistake.

Today, I’m debunking that chart. And I’ll show you the trade to make instead.

Gold Kept Pace With Stocks?

Like I said, CME is a reputable source. It usually puts out great research. But this chart shocked me.

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(Click here to view larger image.)

Source: CME Group

This chart claims that an ounce of gold almost has matched stock returns for the past 100 years. But it’s impossible that gold could match stocks in the long run. The simple reason why is that gold is an inflation hedge. And that’s all it is.

Stocks are also an inflation hedge. Since stock prices reflect earnings, and earnings grow with inflation, stocks should at least match inflation in the long run. But stocks also benefit from growth, which gold doesn’t.

Gold is always gold. If you bought one ounce in 1922, you still have one ounce of a shiny yellow rock. If you bought one share of the S&P 500 in 1922, you now own a completely different basket of stocks. You also own 100 years of earnings growth. That’s a big difference.

Since it’s a reputable source, I knew it likely wasn’t a mistake. There had to be something behind it. So, I went to work to figure out what.

I quickly found the data used in the chart. It was technically accurate. But it was also misleading.

Per the original data, an ounce of gold was worth $20.67 in 1922, where the above chart begins. That had been the price over 40 years. In 1879, $1 was defined as 25.8 fine grains of gold. That changed in the Great Depression, when Congress devalued the dollar against gold several times as part of FDR’s Gold Program. But in the 1920s, gold didn’t fluctuate.

Gold trades freely now. That ounce is worth about $1,675. That’s an increase of about 8,004% in 100 years.

The S&P 500 had a value of about 9 in 1922. Now it’s about 3,600. That’s 39,900% higher.

Math confirmed my hunch. The chart isn’t right. Stocks delivered more than four times the gains. So, how is the same data showing something different?

The Trick of Log Scale

There’s a trick in the chart. Prices are on a logarithmic scale.

On a normal chart, prices are on a dollar scale — the difference between $10 and $20 is the same as the difference between $20 and $30.

Log charts use percentages rather than dollars. Now the distance from $10 to $20 equals the distance from $20 to $40. Both represent a 100% increase.

Log charts are misleading in some ways. That chart is a great example. Gold didn’t keep pace with stocks. It underperformed by more than 50%.

That becomes clear as soon as you look at the y-axis on the right, and see the difference in where stocks and gold are.

I’m not saying you can’t rely on charts. Charts are key to every trade I make.

But you must know what the chart says. You need to know the scaling. You need to know what’s charted. In short, charts aren’t as simple as they seem.

The chart above doesn’t prove that gold “keeps pace” with stocks. If you were thinking of abandoning stocks and buying gold instead as your long-term strategy, I think that would be a mistake.

Always be sure you know what you’re looking at — no matter what the source is. And before you make any investment decision, dive deeper and make sure you aren’t being misled.

Regards,Amber HestlaSenior Analyst, True Options Masters

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