Gold fell around 2 per cent in heavy trading on Tuesday, briefly breaking below $1,600 an ounce as worries that the euro zone debt crisis could worsen triggered a technical selloff.
Gold retraced some losses as other commodities and Wall Street also recovered. Still, the day's tumble cut gold's gain so far in 2012 to less than 3 per cent.
Option volatility spiked as investors bought put options to protect against further downside risk in bullion prices. The precious metal breached a series of technical support levels, suggesting more weakness to come.
Bullion this year has tended to trade in tandem with riskier assets such as stocks and oil, and has not staged many safe-haven rallies this year during times of economic uncertainty.
Analysts said political uncertainty in Greece and a change of leadership in France had investors doubting whether Europe would come through with the billions of euros needed to bail out its troubled economies.
"Absent new monetary stimulus, gold doesn't make sense. When people are fearful of the fiat currencies eroding their wealth, that's when gold catches its bid," said Jeffrey Sherman, commodities portfolio manager of the $33-billion asset manager DoubleLine Capital.
Spot gold dropped 1.9 per cent on the day to $1,607.70 an ounce by 3:16 p.m. EDT (1916 GMT), its largest daily decline in a month. It hit a session low of $1,594.94 an ounce, its cheapest price since Jan. 4.
Gold's has declined $180 from its 2012 high of $1,790 on Feb. 29 after Fed Chairman Ben Bernanke did not hint at a third round of government bond purchases, or quantitative easing, which has underpinned the metal. A strong run of U.S. economic data has further reduced hopes for U.S. monetary easing.
U.S. gold futures for June delivery settled down $34.60 at $1,604.50 an ounce.
Trading volume was on track for its strongest showing in more than a month and about 40 per cent above its 30-day average, preliminary Reuters data showed.
U.S. Treasuries rallied with the dollar, putting pressure on other commodities such as crude oil and copper. Losses on Wall Street also pressured precious metals.
"With stocks slumping and with treasuries rallying and risks generally rising ... investors are withdrawing from the gold market, perhaps as margin calls are made, forcing investors to liquidate precisely when they don't want to," Andrew Wilkinson, chief economic strategist at Miller Tabak & Co said in a note.
The CBOE Gold ETF Volatility Index, often referred to as the "Gold VIX" – based on options of the SPDR Gold Trust – rallied 11 per cent to a reading of 18.6.
Bill Luby, a private investor and author of a blog called "VIX and More," said there appeared to be lots of put buying in the GLD which has inflated the Gold VIX, which was hovering near a historically low level despite Tuesday's spike.
TECHNICAL OUTLOOK BLEAK
Analysts said gold could fall further if it fails to hold above $1,600 an ounce as there is little underpinning from technical charts under that level.
"The fact that support has been broken on a daily, weekly and monthly time frame suggest that this selloff could get worse," said Adam Sarhan, CEO of investment research and consultant Sarhan Capital.
Sarhan said gold was already testing the lows of 2012 when Tuesday's heavy losses sent the metal below heavy daily and weekly support between $1,620 and $1,630 an ounce as well as its 18-month upward trendline on monthly charts.
Silver was down 1.8 per cent on the day at $29.47 an ounce. Platinum fell 1.1 per cent on the day to $1,505.74 an ounce and palladium slid 3.1 per cent to $621.97 an ounce.