Is gold a buy on this dip?

Prices have fallen into the $1,600 range this week. MSN Money columnist Michael Brush says that may represent a bottom.

By MSN Money Partner Sep 27, 2011 10:54AM

By Michael Brush

 

So what do we do next with gold?

 

Back on Aug. 30, in "5 reasons gold is headed for $3,000," with gold trading at around $1,830 an ounce, I wrote that the yellow metal was due for a fairly sharp correction to around $1,630 an ounce because it looked overbought.

 

Just a few days later, gold peaked and then shifted into a September slide. Gold fell as low as $1,623 on Monday and was trading around $1,660 Tuesday.

 

It's hit my downside price target. So what to do now?

 

This is probably a good time to buy gold, either for a trade back up to $1,850-$1,900 in the near term or a possible move much higher in the medium term. That's the view of Michael Painchaud, of Market Profile Theorems, whose bearish near-term outlook I borrowed back in late August. Now he thinks gold will be in a trading range between roughly the current price and $1,800-$1,900 over the next several months.

 

Beyond that, what happens to gold depends on the global economy, the Fed and debt-burdened governments in Europe and the U.S. Let's take those three factors one by one to see why gold could push above $1,900 in the medium term.

 

The risk trade

First, if the U.S. economy recovers, as I expect, then the threat of inflation will pick up again. That will be bullish for gold, since investors often buy gold as a hedge against inflation.

 

Next, if the Fed continues to expand the money supply to boost the economy, which is likely, it will weaken the outlook for the dollar, which would be bullish for gold. Often, gold strengthens when the dollar declines, since gold is priced in dollars, so a weaker dollar increases demand. Plus, many investors buy gold as a store of value if they expect the dollar to weaken.

 

And finally, if governments in Europe and the U.S. continue to struggle to produce believable plans to manage national debt burdens, that will spike fear levels again, sending investors into gold.

 

As I wrote back in late August, this is the scenario that could move gold beyond reasonable medium-term price targets of $2,200-$2,400 to panic levels of $3,000 an ounce if governments' efforts to deal with debt issues seriously break down. Given that German voters oppose bailing out the rest of Europe and that just a few months ago there was talk in Washington, D.C., of a possible debt default, that's not so far-fetched.