Dow Theory Letters Issue 745 was written on December 6, 1978. At the time, the Dow Jones Industrial Average was indicated to be at the 811.42 level. What stood out the most to me was the fact that Richard Russell made very clear commentary on the price of gold and the direction of stocks. Russell made the following commentary:
"It [gold/stock ratio] is telling us that for the foreseeable future (until the next signal), if we do anything we should do it in stocks." page 3.
Anyone familiar with the stock market in 1978 would know that if you had bought a handful of stocks and didn't sell them until 10 years later you would have had a compounded annual growth rate of 8.73% (this takes into consideration the crash of 1987). Russell's comments on being in stocks would have seemed to be very much on target. However, it is his aversion to gold at this time that seems to contradict his earlier comments on gold.
In Letter 742 dated November 1, 1978, Richard Russell said the following about gold:
"Slowly, very slowly, it's dawning on the world that we're witnessing one hell of a bull market-in gold. I've been writing pages and pages about gold in each Letter, trying to get new subscribers in the metal (or the coins), trying to get older subscribers to STAY in gold. Happily, a large percentage of my subscribers are now sitting with large gold positions. And the paper profits (in terms of dollars) are mounting." page 5.
This commentary seems odd because in Letter 745, Russell goes on to say:
"At any rate, it is a bearish omen when the [gold] open interest stays high in the face of a persistent decline, and that is what has occurred." page 6
Russell called himself to task by asking the following question:
"Question: Russell, you were so hot on gold a few months ago. Gold was 'real money,' you said. Gold 'would save the system,' you said. How can you just "turn off" on gold?"Answer: I haven't turned off on gold, I've turned off on gold at this time. The market isn't like your wife or your daughter who you love through thick and thin. We're dealing here with correct procedure and purchasing power. The fact that I advocate gold-backed currency has nothing to do with the fact that I think gold is in a bear trend over the coming months. In this business, you had better learn that the trend makes you the money, not the item. I'd rather buy Cesspools, Inc. if that stock was going up than IBM if IBM is heading down." Page 7
In retrospect, we know that gold went as high as $850 an ounce in January 1980. However, it is interesting to me that Russell said that a bear trend was approaching "...over the coming months." In Letter 745, Russell included a chart that compared the London Gold to the Gold Stock Average.
Russell's favorable comments of gold on November 1, 1978 were well off of the highs from the prior month. However, since Russell was a practioner of Dow Theory and was using the London price of gold along with the equivalent of the XAU gold index to act as a confirming mechanism for the future price of gold, it should have been considered that because the London price didn't fall to the corresponding low set in April of 1978 that there must have been a non-confirmation of the downside trend. Instead, Russell said the following:
"The GSA [Gold Stock Average] has collapsed, and is now down to its previous low for the year recorded last April. Bullion has obviously held up better than the gold shares, but so far the downside non-confirmations by bullion have failed to halt the decline. This kind of action is always indicative of a weak market, and it just seems that there are still too many optimistic gold-holders around." Page 6.
Is it possible that the gold shares are held by the public and speculators (weak hands) and the bullion is held by investors and "institutions" (strong hands)? Somehow I think this relationship has some value. I'm just not sure if Russell called this intermediate move correctly. So I decided to search for an updated version of the London Gold and GSA comparison. Below is what I found in the July 5, 1979 issue:
It should be noted that the exact bottom in the price of gold and gold stocks (red circles) coincided with the publishing of the December 6, 1978 Letter 745.
Also Worth Mentioning:
- Russell said that "Greed and options don't mix." My impression on this remark is that I always thought that the purpose of options is to get exaggerated gains with the trade-off being no equity. Seems to me that greed and options go hand in hand.
- Dow Theory Letters are available at http://www.dowtheoryletters.com/
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