Gold sinks: Correction or time to buy?

By Alix Steel, TheStreet

Updated at 4:15 p.m. ET

Gold prices tumbled Tuesday as investors cashed in their gold positions and looked to riskier equities.

Gold for February delivery fell $44.10, or 3.1%, to settle at $1,378.80 an ounce at the Comex division of the New York Mercantile Exchange. Gold traded as high as $1,417.80 and as low as $1,375 Tuesday.

Stocks were mixed, unable to maintain Monday's momentum. The Dow Jones Industrial Average ($INDU) finished up 20 points to 11,691, the S&P 500 ($INX) fell 2 points to 1,270, and the Nasdaq ($COMPX) closed 10 points lower at 2,681.

The U.S. dollar index was up by 0.4% to $79.47, while the euro was falling 0.4% to $1.33 vs. the dollar. The spot gold price Tuesday was down $33.40, according to Kitco's gold index.

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Gold prices were hammered as early morning selling triggered afternoon sell stops, forcing traders to exit their 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.

Prices breached, 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 could slip to the 200-day moving average of $1,265 an ounce.

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

A new year has brought further positive economic data and has led more confident investors to rebalance 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 billion bond-buying program, an extension of tax cuts and business incentives, a low volatility reading for the markets, stronger-than-expect​ed manufacturing data out of the U.S. and U.K., and booming December auto sales.

Worries over sovereign debt in Europe and tensions between North and South Korea have eased, limiting gold's appeal as a haven asset. Investors seem much more interested in focusing on the Dow Jones Industrial Average's ($INDU) strong showing Monday that pushed the index to a 28-month high.

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But Tuesday's price dip for gold could also 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, a 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."

Gold prices must also contend with the potential of a stronger dollar. Improving confidence in the market has prompted investors to abandon U.S. Treasurys, thought to be a haven asset, which has pushed yields higher as the government sweetens the pot to entice investors. The yield on the 10-year note rose to 3.34% Monday, making the dollar worth more.

Gold and the U.S. dollar tend to move inversely, although the 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 are good for industrial metals like silver, platinum and palladium, and 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 still don't own gold. Jim Cramer points out 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.

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Investors looking at gold's sell-off today would 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.

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."

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. 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 tanked $1.62, or more than 5%, to $29.51 per ounce, while copper was down 9 cents, or 2%, at $4.37 per pound.

Gold mining stocks, a risky but potentially profitable way to buy gold, fell along with the metal Tuesday. Barrick Gold (ABX) closed down 1.8% at $51.67 and Newmont Mining (NEM) dropped 3.3% to $59.08. AngloGold Ashanti (AU) shed 3.4% to $46.88, and Kinross Gold (KGC) finished 2.8% lower at $18.19.

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