Gold Prices: Correction or Time to Buy?

NEW YORK ( TheStreet) -- Gold prices tumbled Tuesday, losing 3.1% of their value, dragged down by technical selling and profit taking.

Gold for February delivery shed $44.10 to $1,378.70 an ounce at the Comex division of the New York Mercantile Exchange. The gold price traded as high as $1,417.80 and as low as $1,375 during Tuesday's session.

The U.S. dollar index was up 0.18% to $79.37 while the euro was down 0.34% at $1.33 vs. the dollar. The spot gold price Tuesday was down $37.20, according to Kitco's gold index.

Gold prices were hammered as early morning profit taking triggered afternoon sell stops, forcing traders to exit positions to lock in gains.

Bargain hunters were then reluctant to try to catch gold's falling knife, choosing instead to wait for prices to bottom out before buying more.

Gold prices breached but then bounced slightly higher from the 50-day moving average of $1,377 an ounce. Typically gold has moved higher from that area of support. If that level is breached, prices will have to look to the 200-day moving average of $1,265 an ounce.

"Short term, the threat of profit-taking corrections remains," says James Moore, research analyst at fastmarkets.com.

Improving risk appetite has also led investors to re-balance their portfolio and diversify into other assets, like stocks.

The slew of good news for equities keeps piling up: Jobless claims hit their lowest point in almost two and a half years; the Federal Reserve's $600 bond-buying program; an extension of tax cuts and business incentives; a low volatility reading for the markets; and stronger-than-expected manufacturing data out of the U.S. and U.K.; killer December auto sales.

Worries over sovereign debt in Europe and tensions between North and South Korea have eased, limiting gold's appeal as a safe-haven asset. Investors seem much more interested in the Dow Jones Industrial Average's strong showing Monday that pushed the index to a 28-month high. On Tuesday investors were wobbling on their stock interest, but kept selling gold nonetheless.

Tuesday's price dip could unearth "bargain-hunting" buying from money managers who sold gold at the end of 2010 and are now looking to buy back positions. Physical buyers, especially those in price-sensitive emerging market countries like China and India, are also keen to buy gold at "cheaper" levels.

"There's going to be a lot of investor inflows and also asset allocation," argues Phil Streible, senior market strategist at Lind-Waldock. "I think that any significant weakness throughout the course of this week should be met with quite a bit of buying."

This so-called January effect for gold doesn't always pan out. In 2010, gold prices slid from $874.50 to a low of $810 mid-month before climbing 3.7% higher in February.

Gold prices must also contend with the potential of a stronger dollar. Improving risk appetite has prompted investors to abandon U.S. Treasuries, usually thought of as a safe-haven asset, which has pushed yields higher as the government sweetens the pot to entice investors. The yield on the 10-year note was at 3.34% making the dollar worth more.

Gold and the U.S. dollar tend to move inversely to each other, although this trend isn't foolproof. Any significant strength in the currency would temper gold's upside.

This downward trend could continue with better economic data perhaps signaling higher interest rates in the near future, but there are other factors that should be supportive of higher prices.

First, improving industrial data is good for industrial metals like silver, platinum and palladium, so gold will probably rise on the back of their rally. Although its upward momentum might pale in comparison, gold rallied 26% in 2010 while silver popped 80%, the interest in precious metals in general should help support prices. The silver market is less liquid than gold which leads to more violent price swings.

Also, the fact is that most investors and money managers don't own gold. Jim Cramer pointed out in a recent article on RealMoney.com that gold is less than 1% of the average fund manager's portfolio worldwide and that gold prices "will not peak until it represents something like 5%, much more the historic mean."

Cramer owns junior miner NovaGold ( NG) for his charitable trust, ActionAlertsPlus , and said recently he fruitlessly tried to buy gold coins, despite the fact that the U.S. Mint said American Eagle one-ounce gold coin sales tanked 53% in December month over month.

Investors looking at gold's sell-off today would most likely wonder if gold's bubble has actually burst and if the 10-year bull run is over. Others, however, are taking this correction as a perfect buying opportunity.

Streible recommends that investors "dabble in on the long side" when prices sink to $1,400 or $1,380 an ounce. He cites resistance at $1,432 and $1,445.

Pratik Sharma, managing director at Atyant Capital, says he would welcome any correction to buy more -- although he favors mining stocks. "Volatility to the downside would make me extremely happy." Sharma is favorable on any gold price over $1,000.

Many bullish analysts say that debt worries out of Europe won't be resolved anytime soon. Despite some signs of improvement in recent U.S. employment reports., growth is still anemic, which many analysts predict will prevent the Fed from raising rates.

A higher-than-expected inflation reading in the eurozone, although largely ignored Tuesday, also underlines the threat of rising inflation. Year-over-year inflation in the eurozone was up 2.2% vs. 1.9% in December. The reading will no doubt put some pressure on the European Central Bank to take a second look at the inflation risk -- benchmark rates have been at 1% since May 2009.

Although higher than expected, the eurozone rate is minimal compared to China's 5.1% inflation reading and underscores that developed nations, not just emerging ones, could start to see inflation in the future.

Gold is the prime investment during times of inflation, or fear of inflation, as a form of money that retains more value than paper currencies.

George Kleinman, president of Commodity Resource, also points out that a rising yield on U.S. Treasuries can be viewed as inflationary. "Why would you lend money to the government for five years or 10 years or 30 years at historically low rates when you're worried about inflation heating up?"

The release of the Fed's minutes from its mid-December FOMC meeting also underscored that there is still some trepidation out there as the central bank made clear it believes the economic landscape is not yet healthy enough to alter its $600 billion bond buying program, leaving the door open to long-term inflation concerns.

Silver prices lost $1.61 to $29.50 while copper ended down 8 cents at $4.36.

Most Recent Quotes from www.kitco.com

Gold mining stocks, a risky but potentially lucrative way to buy gold, were suffering. Kinross Gold ( KGC) was 3.63% lower at $18.04 while Freeport McMoRan Copper & Gold ( GG) fell 1.92% at $117.28. Other gold stocks New Gold ( NGD) and Gold Fields ( GFI) were trading at $9.20 and $17.30, respectively.

-- Written by Alix Steel in New York.

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