Gold prices are up again today.

Gold for December delivery gained 50 cents to $817.30 an ounce on the Nymex. Yesterday, the metal climbed $11.10, or 1.4%, to close at $816.80.

Gold is, however, a long way off its March high of over $1,000 an ounce. And many investors in gold are now left wondering what triggered such a sharp sell-off.

Geologist and S&A Oil Report editor Matt Badiali says the key to gold’s drop is the unwinding of hedge fund-positions in commodities…

Gold and silver got caught in a massive trade that came undone… About six months ago, the Federal Reserve had a choice to make: fight inflation or bail out financials. It chose the latter.

So hedge funds bought the entire commodity sector as part of a bet against the U.S. dollar. These investors based their trades on the same theory – that real assets (gold, silver, oil, grains, and other commodities) were going to increase in value.

The problem is this trade depended on high oil prices. Falling demand meant high prices were unsustainable and, as oil dropped, funds unwound their positions. This boosted the dollar and routed gold.

What’s in store for gold now? According to Matt, prices will fall further…

I think we’re seeing the other side of market exuberance – the same energy that drove oil to $145 a barrel is taking it back down again. Just as that tide brought all commodity prices up with it, everything, including gold and silver, will sink as it washes out.

Matt says expect gold prices to settle in the near term at $770 an ounce, roughly 4% lower then they are now.

Adrian Ash of The Bullion Vault says this makes gold a “screaming” buying opportunity, as history shows we should soon be expecting another steep rebound in the price of precious metals. More from Adrian:

With a near-tedious rhythm, the price of gold has risen in spring, slipped back or steadied in summer, and then enjoyed very much sharper gains once more, before the next year really gets started.

There are no guarantees this shape could be repeated this year. With the gold price falling so far, so fast, from its recent all-time record highs, sentiment among professional and institutional traders has clearly turned against the metal.

Gold buying by the world’s No.1 buyers, meantime, has indeed collapsed, with imports to India dropping by 47 percent in the first half of 2008 from the same period last year. Indian gold buyers tend to account for the surge in physical buying seen during the autumn, as their festival season culminates in Diwali, the “festival of lights.”

Diwali falls at the end of October this year. Reports out of India say the recent sharp falls in gold prices have already led to strong investment and jewellery demand. And here in the West, the economic background remains very bullish for gold — at least according to history.

 

U.S. interest rates now lag inflation in the cost of living by more than three percent. A mountain of leveraged debt still teeters above Manhattan and the City of London. Government debt is rising worldwide, with a true “monetization” of bad loans at Freddie Mac and Fannie Mae now only a few weeks or months away.

If you thought about buying gold but were deterred by this spring’s sudden high prices, it may be worth noting that the case for gold remains as it was. Too much debt, plus too much inflation, threatens to destroy the value of savings and wealth held in paper (whether in bonds, cash or equities). Physical gold, in sharp contrast, cannot be created at will. Owned outright — in your name alone — it’s also no one else’s liability or promise to pay.