This is a little follow-up to my last video about how data is presented to us and how we interpret it. The following chart is yet another one doing the rounds which is supposed to imply something and in turn, cause people to act.
What the chart shows is that the S&P Commodity Index relative to the S&P500 is considered to be “cheap” therefore the only way for commodities to move is up. Before moving into wy this is a flawed analysis we need to understand what the S&P Commodity Index is.
The S&P Commodity Index is defined as –
The S&P GSCI® is a composite index of commodity sector returns representing an unleveraged, long-only investment in commodity futures that is broadly diversified across the spectrum of commodities. The index consists of 24 commodities from all commodity sectors – energy products, industrial metals, agricultural products, livestock products and precious metals but its exposure to energy sector is much higher than other commodity price indices.
Its weightings are as follows –
The keen observer will instantly note that it is an energy heavy index therefore it is more reflective of a comparison between the S&P500 and the energy complex. A glance at the performance of the energy complex offers some explanation as to the current performance of the index.
As can be seen, energy has been under pressure for some time.
So we have our first problem – the comparison is not truly a comparison of all commodities but rather of the energy sector to the S&P500. The original graph also as usual shows the predicted direction of the index courtesy of the helpful little arrow. The implication is that for this to happen commodities must go up. However this neglects other possible outcomes.
- The S&P500 could fall commodities stay flat and the index would also go up. But there would have been no real increase in commodity prices.
- The energy complex could recover and the S&P500 drift and the index would also go up. Once again not indicative of a generalised commodity boom.
- Nothing could happen and the index remains flat for decades.
When looking at charts such as these it is important to understand how they are constructed and when interpreting them it is necessary to look at all possibilities not just the one that suits your narrative.
