Overbought gold finally fell, presenting bulls with an opportunity to buy the precious metal. Given the speed and depth of gold's fall, it will be a while before the yellow metal makes a new high, probably resulting in a period of consolidation.
In our article dated August 17, titled 'Bullish gold enters overbought territory', we had warned a sell-off was imminent. That's exactly what happened last week. We had also mentioned that gold had moved far away from its mean, increasing the possibility of a sell-off. For the mean, we looked at the 30-week moving average, used by a lot of long-term investors to make investment decisions.
The 30-week moving average acts as a support in a bullish market, and when prices fall back to it, they bounce. At the time of writing the article in August, the 30-week moving average was at $1,512 per troy ounce. We looked at the mini-sized gold contracts (YG) traded on NYSE Liffe. On Monday, the average stood at $1,593 and gold fell all the way down to $1,535 intra-day, only to rally strongly and close around $1,630 at the end of the day. That is huge $100 intra-day swing that would have decimated short-sellers.
There are a lot of reasons given for gold's fall. One is that sellers were taking profits on gold to offset losses in equities. It's one possibility, but we'll never know if it's true. It is impossible to know the reasons why the multitude of investors sold and experts did not survey sellers to get the real reason. The other reason given for the drop is that Chicago Mercantile Exchange increased the margins on gold on Monday. But margins apply to both sellers and buyers, and gold rallied strongly after falling on Monday. This proves the margin reason was not correct. So, the only rational explanation for the fall was the fact that gold was overbought, making a correction inevitable.
So, is it time to buy gold? If you did not buy it at the $1,550 level on Monday, it's a little late. In case you are willing to take the risk of losing a lot, you can buy anywhere above $1,535, which was Monday's low, with a stop below $1,460. But that's a huge risk, with a very high loss if the stop is triggered. We'd ideally wait for prices to come close to the $1,500-level, before buying with a stop at $1,460
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