Four reasons to buy gold now

For gold and silver investors this has been one of those weeks when you just wanted to bury your head in the sand, weep, then re-emerge in six months time. Many of the most unemotional traders I know have been wailing like bereaved heroines from a Greek tragedy, while others have been seen approaching strangers in the street and asking them for a hug.

In typical fashion, gold and silver have not been playing to the script. A war breaks out between Russia and Georgia. You'd expect gold to rise. But the opposite happens: we get one of the most violent sell-offs in recent memory. Gold breaks virtually every technical support level. Those on margin are forced to liquidate and the decline accelerates.

Where will it end? Is the bull market over? It could be.

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Then again, it could also be the daddy of all buying opportunities...

What triggered the violent sell off in precious metals

$850 an ounce was a huge number for gold, both technically and psychologically. Many traders will have had stops just below that level. It held for the weekend then on Monday gold went through it like a sharp knife through warm butter. The dam bust and a sea of stops were triggered. Worryingly, key support has now been broken.

Silver, meanwhile, as it sometimes will, has plunged to the downside with a violence that is shocking. Full dollar daily moves have become the norm. Silver never behaved with much respect for conventional technical indicators she has regularly broken key support levels to the downside, throughout this bull run but this last week she has been gesticulating at them like some sort of taunting leprechaun with an ASBO.

This sell-off will have hit precious metals investors in two different ways. Those who hold only physical will have raised a weary eyebrow and observed, "Oh, another August sell-off" before returning to their beach read, possibly Ian Fleming's Goldfinger. But those who spreadbet or use CFDs or other forms of margin, if they were long, will have been bleeding behind the eyes. They won't need any lecturing on the dangers of attempting to trade gold with margin. It is a notoriously difficult thing to do. And to trade silver with margin, as I have said before, is nigh on impossible.

But, speaking of bleeding, didn't Baron Rothschild say that the time to buy is "when there is blood on the streets"? Well, there is blood on Margin Street.

Before we consider what should be our next move, let's just remind ourselves what has triggered this one.

Firstly, the US dollar broke out to the upside (see below). Gold will often trade in an inverse pattern.

What caused that sudden turnaround? The dollar had reached its lowest point since April. There was no change in policy or rise in interest rates. According to James Turk, Federal Reserve reserves of US government paper, held in custody for central banks, grew by an annual equivalent of 38.4%, when the normal growth rate is 17.3%. For whatever reason, central banks no doubt followed by speculators had been accumulating dollars.

However, this is not a chart that befits a currency with negative real interest rates and we can expect a swift bump back to reality. What's more, August, as this chart (below) from Dimitri Speck demonstrates, is the time of year to get rid of the greenback.

Meanwhile, oil has been enjoying its long-overdue correction. Gold, as it tends to, has followed. Though I do not see oil's highs being re-tested in the near future, I do not see its correction going much further either. The fundamentals are too strong. It is sitting on a trend support line now, with the 52-week moving average just below (yes, I know it failed last week with gold, but, more often than not, it's a reliable indicator).

And finally, to add to the mix, just as we had central banks accumulating dollars in late July, we had some significant European Central Bank selling of gold though whose, we do not yet know. According to Julian Philips of Gold Forecaster it "roughly equates to the sale of just over 30.0 tonnes of gold." That is a big number to be dumped on the market, especially at such a quiet time of year.

Four reasons to buy gold now

Remembering that key support has been broken and that in 1974 we had a correction of almost 50% (yes, 50%) in an ongoing bull market, it is with some trepidation that I say gold is a buy down here, just above $800. On top of all the fundamental arguments for gold, which you will all know only too well, here's why:

In the short-term we are due a bounce. For gold to sell off like this for five weeks in succession, even with all the volatility of this bull market, has not been seen since May 2006. We are hugely oversold. We got a big bounce then and should get one now.

The central bank selling appears to have subsided.

The dollar is hugely overbought and due a retrace. The inverse applies to precious metals.

August is the best month of the year to buy gold and silver. These wonderful charts are taken from www.globaledgeinvestors.com . Gold tends to rally from August to year end.

Below we see just the last five years. The percentage increases from August to the end of each year for 2003 to 2007 are 17.72%, 12.78%, 18.31%, -1.02%, 25.48%. That makes an average gain from August to the end of the year, of 14.6%.

Seasonal trading strategies do not always work, but they are an extremely useful secondary trading tool and it is wise to be aware of usual patterns. Buy gold in August is one of the more reliable as is the one you will all know, "sell stocks in May and go away."

If I wasn't already so heavily invested I would be buying all I could down here, if only to trade a short term-bounce. Those who attempt to do so with margin, good luck. I remind you, however, that technical support is broken and we could easily pull back to $730. I consider it unlikely, but it's possible. If it happened, my goodness there would be blood.