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In DIA, dow theory, ETF, ETFs, GDX, Gold, XIU on January 10, 2009 at 7:06 pm

New Dow Theory Position

New Dow Theory Position

JANUARY 9th, 2009 —

The Florida Gators won the national college football championship this week. They won it on defense. Coming into the game, the prolific Oklahoma sooners wowed everyone with five straight games of putting up 60 points or more. They hadn’t, however, encountered a defense like the Gators. The Gators shut down the Sooners with their stiffling defense and held them to a stingy 14 points.

The point is that the old saying “defense wins championships” is just as true in the investment world as it is in the football world. You have to defend your investment account from your opponent – in this case the bear market. The year 2008 was a great example of winning using defense, or as you’ve heard me say “winning by not losing”. Take a look at the returns accross the globe in 2008:

Dow Industrials -34.7%

TSX Toronto -36.2%
S&P 500 -39.3%
Dow Transports -24.8%
Dow Utilities 31.7%
NYSE Composite -41.8%
Nasdaq 100 -42.4%
Russell 2000 -37.0%
Gold +4.25%
Paris -42.7%
Frankfurt -52.2%
London -32.0%
Japan -42.1%
Zurich -34.1%
Sydney -44.1%
Shanghai B -69.7%
Hong Kong -48.9%
GOLD HITS RESISTANCE… You may have noticed that the only market that was positive in 2008 was g old. In fact, gold has been up in each of the last six years. That constitutes a bull market in gold. The reasons are plenty — the massive stimulus packages announced by the central banks of the world, the weakness in the US dollar, and the fear caused by the nasty bear market. As you can see in Chart 1, if gold can clear the $875 hurdle, I believe the third phase of the gold bull market will be underway.

THE VIX HITS SUPPORT… Although the market has rallied 20% from the November 20th lows, the primary trend remains down. One of the things that may provide a headwind for the market is the Volatility Index. Remember that this indicator usually goes in the opposite direction of the market. It has declined to a level of support that may indicate that the stock market rally is coming to an end. Chart 2 shows the support level of the VIX and the S&P 500 rally losing steam.

DOW THEORY REMAINS BEARISH… It’s important not to lose sight of the primary trend. The primary trend is like the tide of the ocean. The secondary trend can be likened to the waves on the tide. The past few weeks have been positive waves (secondary trend), however, it is still too early to tell if the tide has turned. This is one of the most perplexing parts of studying the market. If you can get the primary trend right, you can make a lot of money.
QUESTION: What would it take to signal a new primary bull market?
NDT ANSWER: On this point, Dow Theory is open to interpretation. In fact, two other well known Dow Theorists have already turned positive on this market. In strict parlance of Dow Theory, we would need to see either one of the Dow Industrials or Dow Transports decline to new lows (below Nov 20th closing prices of 7522.29 for the DJIA and 2988.99 for the DJT), while the other index doesn’t. This is called a non-confirmation. Then we need to see both rally and exceed the recent peaks of early this week.
QUESTION: We’ve already seen a rally from the Nov 20th lows of over 20%. Is there any way we can profit from any further rally?
NDT ANSWER: Yes. You can buy ahead of the official Dow Theory signal. In fact, one of the biggest criticisms of Dow Theory is that it lags the market. You either have to accept this fact or decide to “jump the gun”. This involves additional risk and it comes down to a personal choice. I prefer to advise my more conservative clients to wait and continue to play defense.
QUESTION: If I was intent on “jumping the gun” what would I buy?
NDT ANSWER: I would buy an Exchange Traded Fund (ETF) that represents the entire Dow Jones Industrial Average (DIA). Right now you could also consider a smaller position in GDX for gold shares, or the XIU on the TSX for the entire Toronto exchange. In total, only buy a position of no more than 20% of your account and use a stop loss 8% under your purchase price.
CONCLUSION: Continue to focus on capital preservation. He who loses the least in a bear market is the winner. There will be plenty of time to make money once the primary trend turns positive.