See my comments in bold italics:

Oh yes, of course. I should have read my Green book! I never detached that hose so there must be a large air bubble in the system. That would explain a) the gauge reaction, and b) the small amount of fluid I drained / added. I bet once I loosen that hose the expansion tank level will drop as air is bled and more fluid is pulled in. Thanks ngoma!

Second drain and re-fill completed
 

When drained some additional oil poured out. This time I removed the injection pump thermostat hose to allow the system to burp. Filled the system and ran the engine. Eventually the idle speed began to slow as the wax thermostat began to move, at least it was getting the water/soap! The level in the expansion tank dropped about two inches and I added water at that point and shut her down. Tomorrow I'll drive the car a bit and nervously observe the temperature gauge.

On the flip side I've got this drain/re-fill process pretty streamlined. :D

I drove the car around the neighborhood for about 10 minutes or so. The temperature gauge acted normally, no erratic behavior or other gremlins to speak to. In my previous post I mentioned that the water level in the expansion tank dropped about ~1.5 inches and I took that to mean the thermostat had opened and pulled water in. After driving the car around I popped the hood and checked the hoses. The upper hose from the radiator to the cylinder head was very warm, even hot to the touch. Whereas the bottom hose from the thermostat to the lower radiator opening was slightly warm. Finally the hose leading to the injection pump wax thermostat housing was also warm.

Why wouldn't the lower radiator hose be hot like the upper? What way does coolant flow in the engine? Does coolant flow from the engine to the top of the radiator (hot), is cooled by the radiator, and exits from the lower radiator opening and through the thermostat? My goal here is to make sure the thermostat is opening, it must be as I didn't see any signs of overheating.

As a side note both my Nissen radiators I bought from eBay arrived yesterday, they're very nice quality and the price cannot be beat! :cool:

All engines pull from the lower hose so they have some cooling till the last drop of coolant is gone. You may have to block the rad with cardboard or something if you want to heat the whole system without running full load for awhile.

Thanks for the reply 'Greasel. I figured it was logical that the radiator had a temperature drop between its top and bottom. It's also logical to assume coolant is pulled from the bottom and filled from the top; why fight gravity if you don't have to?

I've also noted that the radiator fan is always spinning. As thought the fan clutch isn't "clutching" as one would expect.

The fan always spins whenever the engine is turning, even when the clutch is "disengaged" -- however it will spin much faster when the clutch engages. I have seen one or two where the visco clutch locked up and the fan spun at full speed all the time, but assuming yours is doing what it should, you'll hear it making lots of whooshing noises during the first minute or two after cold startup, then it will quiet down until air from rad gets hot enough to kick it on.

Glad to hear temp is staying where it should now -- definitely sounds like you had an air bubble in there before. We should make it a sticky on here or something about bleeding procedure so that members can be warned about this -- easy to cook the motor quickly if not all the air is gotten out. Good thing you caught it quickly! Paying attention to idle speed is a good way to watch out for it... every now and then even after I think I have gotten all the air out, I'll leave the motor running for a couple minutes and will hear the engine speed start rising again... Sometimes if you've got a persistent little chunk of air somewhere, putting the trans into low gear and driving around with the engine at higher RPM helps burp the last bit out -- seems like spinning the water pump faster helps.

I agree with Anders, the valve cover gasket can sometimes leak from hidden places and make the leak look like it's coming from somewhere else -- check again before concluding headgasket is at fault. If you have the multi-piece cork v/c gasket those really like to leak so makes it more likely. A leaky front cam seal might be able to simulate this as well. Anything leaking at the front will be blown towards the back by airflow thru the rad, but not the other direction, so often is a good method to find the highest and furthest-forward wet spot when trying to pinpoint the source of a leak. :)

Not quite gravity, think thermosyphoning.

In fact, early cars used thermosyphoning instead of water pumps.

Oh, right, of course. I've worked on a few slow-speed diesel generators like Lister, Lister-Petter, and some "Red Stone" models that are water cooled and use thermosyphoning for cooling. In those cases it's typically a 55-gallon barrel which contains the water. Thanks for the reply.

This is a very good tip to catching air pockets in the system. Is should be added to this proposed cooling system bleeding procedure!