Return to Theory

So in traditional fashion, I’d like to return to my original assumptions, that using the basic tenets of Dow Theory is one building block on which other investment theories and strategies can be built upon.  While imperfect on its own, one must pour the concrete before you build the walls, and certainly long before you pick out the window dressings.  The rules of Dow Theory are part of that concrete mix for the foundation of your investment house.

Let’s readdress the rules set forth by Rhea, Russell and others.

·  The Averages Discount EVERYTHING.  The closing prices of the two indexes give us a completeindex of everything known by anybody than can possibly affect the economy and corporate profits.

·  The market consists of three movements which operate simultaneously.  Primary (one to many years), Secondary, (one to three months) and Daily.  Daily movements are ultimately irrelevant, except for over time producing primary and secondary trends, but gain the most attention by the general public.

·  A primary bull is a broad upward movement interrupted by frequent secondary reactions.  These have three phases where the first is a return to normal values, the second is caused by bettering business conditions and is usually the longest, and the third is feverish and speculative.

·  A primary bear is a broad downward movement which serves to correct the excesses of the previous bull markets speculative phases and does not end until the worst that may happen, has.

·  Successive rallies and declines must advance or decline past previous points.  For example, in a bull market the next high and low of the secondary movements within the primary must be higher than the previous high and low.  Of course the opposite is true for a declining market.

·  The movements of the two averages must confirm each other.  The logic is that if there is to be a valid increase in manufacturing and production, there will also be an accompanying increase in shipping and transportation.

·  Volume expands in the main direction of the trend.

·  "Lines" form when both averages remain within an area of about 5% for 2 weeks or longer, indicating a period of very evenly matched buying or selling.  Both averages penetrating their line limits can predict higher or lower prices to come.

·  The word "penetration," under Dow Theory, implies any movement through a given point of one cent or more.  Some scholars demand a one dollar move as a more valid signal.

·  Finally, and most importantly, the primary and secondary movements are NOT susceptible to manipulation.

Putting words to pictures

From a pure theory perspective, I find it hard to argue against the bull market we’ve been in on the equities side since December of 2012.  While the INDU showed growth the year prior, it’s hard to argue in favor of a technical bull since the TRAN didn’t begin to confirm bull until the end of last year, so we have been in a bull market for about 7 months now.  

My personal prejudice would argue that much of the gains of late are heavily influenced by government monetary manipulation, interest rates and the like, and while I “feel” a reckoning is coming, theory states neither primary nor secondary trend can be manipulated and therefore I must concede that yes we are and continue bull market in the equities for the time being.  History being always easier to read than the future, we cannot know for sure if we are seeing a primary or secondary trend bull.
If I Were A Betting ManNone of the following statements are anything beyond my own feelings, no technical analysis, just gut.  A few things that bother me right now.  First, the RSI sits oversold for as long as it did on the TRAN's through the first 2 1/2 months of 2013, yet the sell off was minuscule   This concern is minimal, just interesting.  Second, the TRAN's do appear to be building a beautiful head and shoulders pattern, the INDU's on the other hand look like a ball bouncing up a hill.  Finally, if you cut the right half of both charts off and stick them on top of the left half of the charts, it looks pretty similar.  This is why my gut tells me that although it's straying from the tenets of the Theory, I do not believe that recent growth in the equity markets is legitimate growth, but instead inflationary investing.  When I say that this feeling strays from the Theory, the only thing it strays from is the duration listed for primary trends.  I personally believe a primary trend can last far longer than 1 to 3 years, I think some of the commodity markets have proven this, but Dow Theory is used for investing, and investors don't own things through the duration of a 10 year primary trend, savers do that.  So I will stick with the theory as is.For the time being, because of trend theory I will not be liquidating any positions at the moment, buy because of my gut I won't be adding anything either.
Tomorrow... where should we be adding right now and why!!!

Cheaper than Dirt

For those of you not aware, there's a site out there that levels the playing field in terms of cost comparison.  The PricedInGold website, hosted and run by Charles Vollum, is a fantastic source for price comparison and current economic understanding.  If you would like to listen to a recent interview with Mr. Vollum, please CLICK HERE. There is one basic tenet you must accept, or at least suspend disbelief long enough, in order to fully understand and appreciate the information provided.  You must approach with an understanding that gold is money... not a commodity.  OK, in reality it's both, but that's why it's money.  What gold is not, is a "speculative" commodity.
Now, for those of you incapable of viewing anything besides paper as money, for the sake of your education, pretend we're using any other commodity as the medium of comparison.  In reality we all think this way, while our initial reaction at the grocery store is to count how many US Dollars we've spent, what we really do in the back of our heads is compare products to each other.  We tell ourselves, we can buy two boxes of spaghetti or only one box of penne.  We can buy our kids those toaster pastries which are unhealthy and expensive, or for the same amount of money actually fix them a healthy breakfast.  We can eat for a week on a box of cereal or a month on a container of oatmeal.  We all do this, so I'm asking, is that instead of thinking in terms of how many US Dollars something costs (because let's be honest, over the last 10 years the diminishing value of US Dollars and the inability for average household income to keep up has raised our cost of living and our blood pressure), think in terms of relative values between products.  Too confusing to think of how many ears of corn compares to gallons of gas compared to your morning coffee and college tuition?  That's where the single medium of gold comes in.  Frankly, that has been the purpose of gold since we moved beyond etching paintings on cave walls and small tribes traded through barter into a more organized system. Information's great and all, but how is this practical?  Information for its own sake is generally reserved for academics, but practice is what really matters to the rest of us.  What you will learn by a little time spent on this site is that today, we live in one of the least expensive times in our history!  It makes sense.  100 years of massive technological advances and we still enjoy the same coffee beans and sourdough bread we did back then.  Technology should naturally cause price reduction over time, production costs should diminish and the amount of money in circulation to buy the same goods and services can be deflated.  This is natural progression.  Thousands of years ago most people were farmers, or they didn't eat.  Today, a small handful of people have the ability to feed the world (why the world isn't fed today is a conversation for another day).  If you compare these goods to each other and eliminate the Federal Reserve Note middle-man, this is exactly the case. So why does it make sense to view gold as a constant?  Well the only other option is to argue that since 1975 or so, it's become 3900% more valuable (and at the highs of 2011 it was almost 5500% more valuable).  I have a hard time swallowing that.  It's industrial uses are certainly there, but nothing like other precious metals like silver.  Jewelry production certainly hasn't increased that much, and mining production hasn't fallen off enough to increase the demand.  Yet gold will continue to climb on international demand, despite US market analysts at the major media houses whose budgets are paid primarily by the Wall Street firms will try to tell you that gold is in a speculative bubble (which, according to them has perpetually and repeatedly already "popped" since about 2007 - see recent Roubini statements). So let's say I'm right.  The majority of the world knows I'm right, and even a healthy minority of Americans do too, but let's just pretend that I am right and gold is actually the constant that levels the playing field for everything else.  Then how can I possibly argue that goods and services today are the cheapest they've ever been when the constant we're measuring it against is itself at an almost 4000% return in terms of US Dollars had you owned it since 1975?  Well, if gold is the constant, and as mentioned above technology and other factors decrease production costs and therefore should lead to decreased prices, then yes, things should "always" be cheaper as time marches on. A few examples of some everyday things (ok, so not everyone goes to Yale)...

yellow line is cost in gold, the gray-blue line is USD

And a few things to consider regarding your own household income...

yellow line is cost in gold, blue is cost in USD

The Fabled Ratio

DJIA

open11,934.58

close 12,043.56 up 108.98

day high 12,098.81

day low 11,934.05

today's volume 177,920,112

3mo avg. daily volume 170,635,679

Average P/E  13.4

1 year change +18.73%

DJTA

open 5,219.23

close 5,259.19 up 45.04

day high 5,270.02

day low 5,196.86

today's volume 14,701,568

3mo avg. daily volume 16,872,528

Average P/E  20.0

1 year change +24.00%

The DOW/Gold Ratio has been talked to death (or life possibly in this case) for decades.  All foolish speculation aside, watching ratio's instead of prices give a much more relative and ultimately realistic view of how different markets react to each other.  People have talked ratio's for millennia, dating back in all cultures to the barter days before kings and kingdoms placing their faces and claiming authority through seigniorage.  Those same kingdoms have always tried to fool the public by shaving value from those mandatory coins either literally, or by devaluing them by using other less appealing products like copper, tin or paper, and most popular today, the 1's and 0's of binary in today's digital money.  But ratio's have held true, and those who ignore them are doomed to repeat the fools errands of those past.

When Charles Dow created his averages of the markets, they were based on a simple principle, the cumulative value of the average equals an ounce of gold... This ratio has stood the test of time as an indicator (at the very least) of over or undervaluation of the famed Dow Jones Industrial Average.  As rampant speculation through cheap leverage comes to a grinding halt, the averages have begun to realign themselves.  Although the grand US Dollar itself, incumbent placeholder as the true international reserve currency may be the cause for the diminishing role in industrial production and demand and a global cooling of speculation, as money exits investments and turns towards safety, the dollar, being the cause, is no longer the only place large scale investors are turning to.  Likely, as prices shift, one can assume the general investor will be soon to follow, although as usual, a day late and a very literal dollar short.

With a very legitimate, but elementary understanding of the DOW to Gold Ratio, one assumes that the most common way to track if the DOW to Gold Ratio is accurate is that when the DOW goes up, Gold goes down, and vice versa.  However, there are more scenario's the investor should be aware of, and although not perfectly cyclical, here is a look at how those could unfold.

 Scenario 1 shows a period I believe to be over at this point.  As example, see the two charts below showing the drop and rebound in the markets from 2008/2009 until today. The drop in the DOW from around 12,000 to 6,500 was roughly 45% fall.  Gold fell from around 1,050 to 700, a 33% fall.  See Scenario 2 above.  What is more telling is the recovery time.  The last time Gold reached a low price retrenchment that lined up with the old highs of 1,050 before the 2008/'2009 fall was October/November 2009, about exactly a year after it hit bottom.  Since then, gold has made an impressive $500 an ounce rise.  The DOW, on the other hand is, for the first time since, seeming to make that same claim as we speak, taking about 2 1/2 years to do so.  Despite the talking heads on TV, this is not recovery momentum.  This is clawing your way out of a fallen house.  Although I am no chartist, what the DOW appears to be doing is making a head-and-shoulders pattern which should signify downturn and should put the kibosh on those still determined to live in recovery fairy-tale land.

With the cause of the problem lying with the devaluation of the US Dollar, the likelihood that both sides of the ratio continue to rise, even at different levels should subside.  I would argue that we are currently seeing Scenario 2 and 3 play out, as the DOW long-term should remain level or slide down, the price of gold should increase over the same period of time.  During the Final manic phases of the Gold Bull Market, the DOW should have reached bargain prices causing wise investors to begin liquidating preservation positions like Gold and buying equities for pennies on the dollar.  Eventually, should the government choose to attempt to consolidate the value of our medium of exchange, making the assumption we still call it "the Dollar," our currency will find bottom values and interest rates rise.  At this time most of the wise investors will have sold their preservation positions off to those who are certain it is the right thing to do because everyone else around them seems to have figured it out already, and Gold will begin it's long decline as the equities markets begin to climb again and interest rates eventually seem reasonable.  Unfortunately for most, to find these bargains, the only way is to go against the flow or general consensus, which most will be incapable of bringing themselves to do.