NEW YORK Spot gold prices hovered at 2 1/2 month lows close to $1,560 an ounce in New York on Thursday afternoon as fund selling resumed, forcing bullion to break from its traditional inverse correlation with the dollar.
The outlook was bleak with money managers advising investors lock in cash and wait for even lower prices.
"We are calling for clients to be very overweighed in cash and that means minimally 30 and up to 50 percent or even more depending on risk tolerance with the simple premise that against the technical in the S&P 500 and the problems in the euro zone which are not anywhere being resolved," said Stanley Crouch, Chief Investment Officer, Aegis Capital, which has about 2 billion in assets under management.
"We think that there is a much-higher-than-average likelihood of being able to buy cheaper assets in the near and medium term."
Early gains, which saw prices hit an intraday high just below $1,600 an ounce, were driven by short-covering, but once that petered out even the stronger broader financial markets and a weaker dollar could not offset fresh fund selling.
That flight to cash sent prices to fresh 2-1/2 month lows in the afternoon before the market stabilized between $1,564 and $1,570 an ounce in late after-hours trading.
Spot gold was down 0.35 percent at $1,568.65 an ounce at 4.43 pm EST (2143 GMT), building on its biggest one-day decline in nearly three months on Wednesday.
U.S. gold futures for February delivery settled down $9.70 at $1,577.20 an ounce.
Spot bullion hit a session low of $1,560.36, a low last seen at the end of September when the last major sell-off took place.
At that time, there was talk hedge fund manager John Paulson might have liquidated his holdings to meet end-of-year client redemptions. Regulatory filings in November showed Paulson & Co had cut its gold holding by a third in the third quarter.
"You have forced selling of gold as investors were getting margin calls and I heard discussions of hedge funds closing. The selling pressure is being put on one asset that's up in value for the year in a notable amount," said Mark Luschini, chief investment strategist of broker-dealer Janney Montgomery Scott with about $54 billion in assets under management.
The precious metal has lost 11 percent of its value this month, putting it on track for its first monthly fall since September and its weakest December since 2008, when the global credit crunch was at its worst.
Bullion fell in tandem with the dollar as the euro recovered from Wednesday's 11-month low after two strong regional manufacturing surveys and other data.
Equity markets were also buoyed by data, which showed weekly applications for unemployment insurance fell to a 3-1/2 year low, while a gauge of New York state manufacturing activity rose to its highest level since May and another measure of factory activity in the mid-Atlantic region showed a surge in new orders.
Prices are prone to volatile moves at the end of the year on thinning liquidity as many investors close their books for the year and move to the sidelines, waiting for a fresh start in January.
Although gold is regarded as a safe haven that can shield investors in times of uncertainty, it has increasingly become prone to pressure from the wider financial markets, moving more in tandem with other assets as investor sentiment remains fragile.
The market is likely to remain weak until the new year as year-end fund selling continues without any industrial buying, said Miguel Perez-Santalla, vice president of sales at Heraeus Precious Metals Management.
"Nobody's buying inventory before the year-end. There would be a lot of potential buying if this had happened a month ago," he said, adding that he was surprised prices have fallen this low.
Gold's 200-day moving average: link.reuters.com/fux55s
Graphic on year-to-date metals performance: link.reuters.com/taj93s
Prices broke below the 200-day moving average in the previous session, seen as a bearish signal for the market, but technical analysts said it might be too early to suggest the bull trend was over.
The relative strength index on spot gold remained below 30, for a second session in a row, indicating an oversold market which could attract some buying.
Helping ease some immediate concerns about the euro zone debt crisis, Spain attracted solid demand for medium- and long-term bonds, paying over 2 percentage points less than Italy to issue a five-year bond this week.
Holdings of SPDR Gold Trust, the world's largest gold-backed exchange-traded fund, were unchanged at 1,294.796 tonnes by December 14, even while prices fell.
"Investors with a medium- and long-term view are remaining loyal to gold, and gold ETFs are still showing no outflows. In our view, bargain hunters are soon likely to take advantage of the low price levels," Commerzbank analysts said in a note.
Other precious metals were mixed with spot silver clawing back earlier losses to rise 0.11 percent to $29.23 an ounce by late afternoon. The metal has fallen about 10 percent so far this week, pushing the year-to-date performance into the red.
"Silver's rally this year was driven by strong investment demand building upon relatively healthy industrial consumption," Barcap analysts said in a note.
"However, the industrial outlook for the metal has weakened and investor interest has turned negative in a market in fundamental surplus, exposing prices to the downside."
Spot platinum eased 0.11 percent to $1,402.50, after earlier hitting a two-year low of $1,372.
"Platinum's taking a bigger beating. There's no industrial demand," said Perez-Santalla.
Palladium rose 0.45 percent to $617.0 an ounce.
(Reporting By Josephine Mason; editing by Jim Marshall)