Despite the massive price increases gold has enjoyed over the course of the year, we have yet to enter the strongest season for precious metals. Gold prices are up more than 38% since January lows, making 2011 (so far) one of the best years on record. Gold this morning is trading slightly higher to $1825 per ounce in anticipation of the release of economic data later in the day.

Now that September has begun, it’s time to look again at some seasonal factors that will no doubt have an effect on the gold market for the next several months. There are two main demand factors for gold; physical jewelry demand and investment demand. Throughout the last several years, the ratio of investment demand to physical demand has been increasing steadily. Now more than half of the gold sold worldwide goes to investors, which has been giving them the upper hand in terms of how they affect the markets. That said, physical jewelry demand has not gone away and we expect it to play an important and unique role in the coming months.

Below are the yearly gold charts for the last five years. Take a look at trading patterns between September 1st and the end of the year on each of these charts.

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The first thing that jumps out is the fact that from September through the end of the year, gold has increased significantly in value at least 4 of the last 5 years. There is clearly a pattern to the later part of the year that makes a strong argument that buying in September generally yields a solid return by the end of the year. Even so, there is another more subtle feature that is even more telling of the power of seasonality for gold.

Can you find a single correction of more than 10% that happened after September 1st in any of the last five years? Can you find any significant pullback that lasted more than a couple weeks? Since 2006, there has only been one example of gold experiencing a significant, sustained correction. That was in October of 2008 on the heels of the financial crisis when profit taking and market instability were at decade long highs.

The point is that significant protracted corrections are very rare in the latter months of the year. This is where physical jewelry demand can really be seen in gold price patterns. A series of major gift-giving celebrations around the world kicks off with the Indian wedding season and Diwali festival. This is followed up by the traditional holiday season in the west, which is then followed by the Chinese New Year celebrations in the Far East. The net effect is that demand for physical gold jewelry will peak in the coming months.

In the past, autumn has often seen jewelry demand drive prices significantly higher, which will not likely happen this year. Because of the massive increases in investment demand over the last several years, jewelry buying has less of a price lifting effect than it used to. What we are likely to see is a lot of bargain buying. Keep in mind that jewelers are often “un-hedged” meaning that higher gold prices make it much more difficult for them to turn a profit on sales. What’s the answer then? Buy the dips. As jewelry demand ramps up, it’s very likely that it will be seen primarily when investment demand sags and allows the market to come down a bit in price. When this happens over the next few months, you can bet that physical buyers will be entering the market to snap up what they can at bargain prices. In the end, this will probably make any further corrections in the gold price shorter and shallower than we have seen over the last month. As a result, we expect physical buying to significantly lower the downside risk over the next few months as we come into gold’s strongest season.