Gold Set For Big Weekly Drop On Deflation Fear

In early trade, gold actually ventured into negative territory for 2012. On Thursday, gold slid 2.5 percent, a day after U.S. Federal Reserve policy makers took only modest steps to stimulate the world's largest economy.

The Fed opted to lengthen its Operation Twist program of selling short-term government debt to fund purchase of longer-dated securities. But many investors had hoped for a third round of quantitative easing (QE3) in which the Fed made outright purchases of U.S. Treasury debt.

Inflation fears have helped fuel several years of strong gains for gold, but now investors are starting to worry about deflation after reports this week showed signs of slowing economic activity around the world.

There is zero inflation out there. With gold being well received as a risk asset, the price is deflated because of the rising dollar, said Phillip Streible, senior commodities broker at futures brokerage R.J. O'Brien.

Streible said investors may rebuild gold positions after the latest price pullback, and might rethink the flow of funds into U.S. Treasuries because they have reached a saturation point.

Spot gold was up 0.1 percent at $1,566.40 an ounce by 12:52 p.m. EDT (1652 GMT), just $3 above the closing price for 2011.

The metal was on track to fall 3.7 percent this week for its second-largest weekly decline of the year. It briefly turned negative for the year in early trade.

U.S. gold futures for August delivery edged up $1.80 at $1,567.30 with trading volume at about half of its 30-day average, preliminary Reuters data showed.

Silver was down 0.4 percent at $26.73 an ounce.

Gold drew some safe-haven bids a day after Moody's downgraded 15 of the credit ratings of world's biggest banks to reflect the risk of losses from volatile capital markets. Worries about the euro-zone debt crisis also supported the metal. Prices at 12:52 p.m. EDT (1652 GMT)