Bullion extended losses as Wall Street stocks more than halved gains following news that Standard & Poor's was poised to place all 17 euro zone nations on credit watch negative, meaning that members such as Germany and France risk losing their AAA rating in the next 90 days.
"Gold is not getting stronger with all the uncertainty in Europe, and the S&P story has exacerbated gold's losses more," said Michael Matousek, senior trader at US Global Investors Inc, which has $2.5 billion in assets.
While dealers were hesitant to read too much into a session marked by the lowest futures volume in three weeks, many were surprised by the initial divergence between bearish bullion and a rallying stock market. Until today the correlation between gold and stocks had been at its strongest in over a year.
Spot gold fell 1.3 percent to $1,723.90 an ounce by 2:57 p.m. EST (1957 GMT), after rising nearly 4 percent in the previous week.
The metal's decline accelerated after the S&P news sent gold below its 100-day moving average. Gold initially rose but failed to rise above $1,760 an ounce -- a level the metal last week tried to clear several times, but failed each time.
US gold for February delivery settled down $16.80 at $1,734.50 an ounce. Volume was about 60 percent below its 30-day average, with some traders saying a lacklustre December could be in store as many trading books shut early.
Spot silver was down 1.3 percent to $32.15 an ounce.
A credit downgrade for the euro zone's core economies would cast a pall over a week in which many traders were expecting to see more efforts to end the debt crisis. EU officials said S&P would place all 17 nations on credit watch negative; the Financial Times said six countries including Germany and France would then be in jeapardy of losing their AAA rating.
The leaders of France and Germany agreed a master plan for imposing budget discipline across the euro zone, saying the EU treaty will need to be changed in the search for a sweeping solution to its debt crisis.
GOLD OUTLOOK MIXED
Some investors were turned off by gold's reduced safe-haven appeal.
Alec Letchfield, CIO of wealth management at HSBC Global Asset Management, told the Reuters 2012 Investment Outlook Summit that he has funded higher equity allocation by reducing exposure to gold.
"We still have gold in the portfolio but it's a bit less," he said. "We've been reducing (gold) since summer, we were buying equities. My suspicion is a bubble is being formed."
S&P 500 sharply cut gains as news of possible European sovereign debt downgrade shook some of the recent optimism about the euro zone's outlook.
"We have seen gold moving along in tandem with equities. However, it is way too early to say that gold will lose its safe-haven status at some point," said David Meger, director of metals trading at Vision Financial Markets.
The 25-day correlation-log between gold and the S&P 500 was at 0.62, near its tightest positive link in more than a year, Reuters data showed.
Platinum group metals also reversed early gains to end lower. Palladium fell 1.6 percent to $632.22 an ounce, and platinum dropped 1.7 percent to $1,521.49.