New Low Observer's  Instablog

The world of Dow Theory was abuzz after the Dow Jones Industrial Average and the Dow Jones Transportation Average charged to all-time highs on March 5, 2013 (found here). At the time, the Dow Jones Industrial Average (DIA) had finally capitulated to the inexorable forces that had long since propelled the Dow Jones Transportation Average (IYT) above the 2011 all-time high. The confirmation of a Dow Theory bull market came when the Dow Jones Industrial Average finally exceeded the all-time high of 14,164 set in October 2007.

The action of the Dow Industrials and Transports has been so compelling that Dow Theorist Richard Russell acquiesced to the strength of the market on March 11, 2013 by saying the following:

"Yes, I know that this market is uncorrected during its long rise from the 2009 low, and I know that there are risks in buying an uncorrected advance that is becoming uncomfortably long in the tooth, but my suggestion is that my subscribers should take a chance (after all, Columbus took a chance) and take a position in the DIAs."

In the same posting, Russell later punctuates the point by saying:

"I really believe that subscribers should take a flyer on this market. After all, after weeks of flirting with a new high in the Industrial Average, the Dow finally confirmed the previous record high of the Transportation Average. With the Industrials and the Transports both in record high territory, I think being in the market is justified under Dow Theory."

By all indications, this Dow Theory bull market indication is the real deal, especially when it is endorsed by Russell's 55 years of experience on the topic. The implications of this signal are significant for one very important reason, this time we've achieved a secular bull market indication (learn about cyclical and secular trends).

Throughout stock market history, cyclical primary bull markets tend to last 2-4 years. These bull markets require rapt attention to the nuances and vagaries of changes in the trend. The last indication of a cyclical primary bull market was on July 23, 2009, when the Dow Industrials traded at 9,069.29. Based on our interpretation of Dow Theory, we received a cyclical primary bear market indication on August 2, 2011 when the Dow Jones Industrial Average was at 11,866.62.

Secular bull markets, on the other hand, require very little attention and have typically lasted between 15 and 18 years. Secular bull markets are the proverbial sweet spot of investing with the trend, where "buy-and-hold" is the rule. The two most prominent secular bull markets resulted in the Dow Jones Industrial Average increasing by 10-fold or more. From 1942 to 1966, the Dow rose from 100 to 1000 and in the period from 1982 to 2000, the Dow went from 1,000 to 11,722. If the current implications are correct, we could be on the cusp of a run to Dow 100,000.

Click here to see what the lone Dow Theory holdout is...

On February 14, 2013, Berkshire Hathaway and investment firm 3G announced a deal to buy H.J. Heinz (HNZ) for $28 billion, or $72.50 per share. Naturally, Warren Buffett, not being one to get the short end of any stick, is investing only $4.4 billion in Heinz common stock and another $8 billion in preferred shares yielding approximately 9%. The rest of the purchase is being financed through investment group 3G and bank borrowing.

According to the Wall Street Journal, Warren Buffett "…has previously expressed disdain for private-equity buyouts that employed excessive leverage." However, as the details of the acquisition have unfolded, it becomes apparent that the leveraged nature of the transaction is on par with the deals that Buffett has spoken out against. So what is the motivation of Warren Buffett to engage in such a transaction? In this case, the allure of an inflation hedge that performs much better than gold in high inflation environments and that is proven to succeed after the high inflation period ends.

In the past, we have been outspoken on the matter of investing in food processing companies instead of gold and gold stocks if you want to beat inflation. On December 17, 2008, we pushed the idea that Sysco Corporation (SYY) is an inflation hedge that will beat gold and gold stocks. Our closing remark were, "…if you're of the mind that inflation is coming down the road, with all this liquidity being injected into the economy, then SYY might be a good "long-term" hedge against inflation (found here)."

In a December 1, 2010 article we re-iterated that value of inflation protection provided by food processors by comparing ConAgra (CAG), to Newmont Mining (NEM) during the gold bull market from 1974 to 1980. This was a time when ConAgra exceeded Newmont Mining by 10 times. Again, this was within the gold bull market from 1970 to 1980 (found here).

One article published as recently as September 20, 2012 was titled "Gold Stock Investors: To Beat Inflation Look to Food Processors, Producers and Distributors (found here)." In that article, we said, "As an alternative to the 'mines' of precious metal stock investing, we've recommended investing in food processors, producers and distributors that have a history prudent of dividend increasing policies to take advantage of the expectations of high inflation down the road."

We cannot emphasis enough the fact that there are vastly superior alternatives to gold and gold stocks if you want to beat inflation. Additionally, investment in companies like Heinz will be richly rewarded even as the period of inflation comes to an end. This will not be the case for gold and gold stocks, as found out by gold permabulls in the period from 1980 to 1999. This explains why Warren Buffett would be involve in the Heinz transaction, it is the appropriate alternative to buying gold or gold stocks if runaway inflation is expected down the road.

Source:

• Matt Wirz and Ryan Dezember. Berkshire Stomachs Leverage for Heinz Buy. Wall Street Journal. February, 14, 2013. http://blogs.wsj.com/deals/2013/02/14/berkshire-stomachs-leverage-for-heinz-buy.

Disclosure: I am long SYY.

Gold, and to a greater degree gold stocks, typically decline whenever there is a general stock market decline. We have examined the price of gold and the fluctuations of gold stocks as far back as possible. From our experience there have been few instances when gold, and especially gold stocks, have parted ways when the overall market declined.

The following are our Seeking Alpha articles on gold and gold stocks:

"Why Gold Will Decline More than the Markets" (found here: http://seekingalpha.com/article/106544-why-gold-will-decline-more-than-the-markets) from Nov 18, 2008. In this article, we cite the work of David Marantette, author of the Goldstock Letter, who argued that when the Dow declines -10% or more gold and gold stocks are likely to decline by a greater percentage. The data covers the period from 1975-2007.

"Gold - Not the Safe Haven People Think it Is" (found here: http://seekingalpha.com/article/109880-gold-not-the-safe-haven-people-think-it-is) from Dec 9, 2008. Due to the outrage at the first article, and claims that gold did well in the "great" Depression, we examine the performance of gold stocks from 1924 to 1933. We included the high and low prices from Poor's (predecessor to Standard and Poor's) of gold stocks from 1924 to 1933 to show that gold stocks got hammered at the same time that the Dow Jones Industrial Average got crushed. In fact, the decline in gold stocks began in 1925 rather than 1929 for general equities and ended at the same time in 1932.

"The Lessons of Homestake Mining in Gold Bull and Bear Markets" (found here: http://seekingalpha.com/article/234105-the-lessons-of-homestake-mining-in-gold-bull-and-bear-markets) from Nov 2, 2010. The gold stock from which all other gold stocks myth springs from, we examine exactly why Homestake [HM] was unique as a gold major in its ability to succeed where other gold stocks haven't. We point out government and internal policies that helped [HM] be the exception rather that the rule. Unfortunately, those who wish to propagate "stories" about gold stocks doing well in the "great" Depression usually hoist [HM] as the token gold stock.

There is one period that gold stocks did act as non-correlating asset and that was the period from 1972 to 1974. While the Dow Industrials were going down by -40% gold stocks made a massive move up as represented by the Barron's Gold Mining Index. We believe this was due to the recent actions by the Nixon administration closing the window on gold thereby allowing gold to find its equilibrium, subsequently gold stocks followed along. Unfortunately, from 1974-1976, gold declined -50% and gold stocks got crushed to the tune of -66%.

We hazard to bring up the 6 month period from March 2008 to October 2008 when gold sank -30% and gold stocks declined -68%, since those in denial, and not knowing history,claim that it was an anomaly.

Our article titled "A Strategy is Needed For Lagging Gold Stocks" (found here: http://seekingalpha.com/article/304922-a-strategy-is-needed-for-lagging-gold-stocks) introduces our Gold Stock Indicator specifically designed to address the very question that you have, determining when is the most ideal time to buy and sell gold stocks.

Our Gold Stock Indicator provided the following buy recommendation of DUST on February 8, 2012 (found here: http://seekingalpha.com/instablog/242682-new-low-observer/293271-gold-stock-indicator-points-down). Subsequently, DUST increased +54% by the time we recommended selling DUST and recommended preparing for a buy indication of NUGT on April 4, 2012 (found here: http://seekingalpha.com/instablog/242682-new-low-observer/474131-gold-stock-indicator-nearing-a-buy-signal-for-nugt).

The purpose of our Gold Stock Indicator is to circumvent the common misconceptions of holding and hoping when it comes to gold stocks, at the same time avoid periods of substantial decline in gold stocks like that of November 2010 to the present.

As we've said many times before, gold stocks can be easily gutted IN THE MIDDLE OF A GOLD BULL MARKET as outlined in our previous work.

• In the following link accessible to subscribers of our site, we outline our specific plan of action based on our Gold Stock Indicator. Continue reading...

Disclosure: I am long NUGT, IAG, NEM.