NEW YORK ( TheStreet ) - Gold prices lost steam Tuesday on the news that German Chancellor Angela Merkel rejected raising Europe's bailout fund cap and as the Federal Reserve offered no hints at more quantitative easing.

Gold for February delivery closed down $5.10 at $1,663.10 an ounce at the Comex division of the New York Mercantile Exchange and prices were extending losses in after-hours trading. The gold price has traded as high as $1,681.70 and as low as $1,654.40 an ounce while the spot price was down $31, according to Kitco's gold index.

Silver prices settled up 25 cents at $31.26 an ounce while the U.S. dollar index was rising 0.78% at $80.20.

Gold had a crazy and volatile day. First, the metal clawed higher as the U.S. dollar headed lower and the euro rallied along with oil and stocks. Gold then spiked on reports that Iran will practice closing the Strait of Hormuz. At first gold rallied because investors thought the drills were permanent, but the positive momentum was short-lived after Reuters reported that Germany's Chancellor Angela Merkel would oppose raising the €500 billion funding cap for Europe's bailout fund. The hope had been that there would be a discussion of raising the ceiling at the next big summit in March 2012.

Gold then spiked significantly lower after the Federal Reserve disappointed investors. In its last meeting of the year, the central bank's open market committee upgraded its growth assessment for the U.S. economy, saying inflation was moderating although the job landscape remains weak. But there was no hint of plans to embark on another bond-buying binge. The central bank also left alone its communication policy.

"There were heightened expectations that Fed would be more proactive in limiting the slowdown," says Phil Streible, senior commodities broker at R.J. O'Brien. "The Fed said the economy is slowly expanding but refrained from taking new actions in the market. As a result we saw the wind comes out of the sales of gold, silver, and S&P 500."

Streible did say that when investors panicked that Iran was taking aggressive steps to shut down the Strait of Hormuz he had clients calling in to buy gold.

"I immediately had customers buying it specifically for the geopolitical safety play." The clients put strict selling levels in place to protect profits, which could have been activated today and accelerated selling, but Streible says this shows gold is still a safety play and that "this type of problem is eventually going to resurface."

In the meantime, the dollar is benefiting as the safe haven of choice which is pressuring gold. "Gold faces the threat of further pressure in the short-term ," said James Moore, research analyst at FastMarkets.com, "as dollar demand increases, particularly given the sharp increase in bearishness towards the euro."



Despite Monday's steep 3% drop, however, the biggest gold ETF SPDR Gold Shares ( GLD) shed less than 1 ton which means that gold did find buyers.

Mihir Dange, founder of Arbitrage, said "there must be some kind of fund liquidation." Dange thinks that gold should be $200 higher but that end-of-year rebalancing of gold -- selling it for a profit or dumping it from portfolios -- is dominating the market.

Hussein Allidina, head of commodity research at Morgan Stanley, has an average price forecast for gold of $2,200 an ounce in 2012. David Darst, chief investment strategist at Morgan Stanley, said this is primarily "due to monetary expansion and the lack of faith by investors globally and the desire to diversify the reserves of central banks and individuals."

Frank Trotter, president of EverBank Direct, doesn't see a rally that strong next year but does see a 10% to 15% rise which could create a trading range of $1,800 to $2,000 an ounce. Trotter also said investors have been rotating out of the company's unallocated accounts and have been taking physical delivery instead, "four to five times what it was three-four years ago."

"I think gold is an investment," said Trotter. "I think as people think a euro breakup is really coming other people will start to take a look and say there is something to this" and start accumulating physical gold.

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One worry brewing is India. India consumed 963 tons of gold in 2010, but in the third quarter jewelry demand fell 26%, according to the World Gold Council. "We would expect Indian demand to pick up but it depends on the currency," said Marcus Grubb, managing director at the World Gold Council, and a stronger dollar has been hammering the rupee.

The U.S. dollar is currently up around 1% vs. the rupee, which has left many experts worried about a lack of gold buying in the country.

"India as a nation is quite possibly the planet's largest buyer of bullion," wrote Stephen Guilfoyle, economist at Meridian Equity Partners. "When the home currency is weak against a commodity priced in dollar terms, the home team not only will be discouraged from buying said commodity, but will be motivated to take a profit because the commodity is worth much more of the home currency."

According to Darst, Indian citizens own a fifth of the world's above-ground gold supply. A big swing in their consumption habits would create waves for the gold prices but Darst thinks their commitment to gold is strong. "In India 73% of their 1.1 billion people still live on the farm and for them gold is the bank," Darst said.

Gold mining stocks were slipping Tuesday. Kinross Gold ( KGC) was down 3.77% at $12.24 while Yamana Gold ( AUY) was down 3.68% at $14.92.

Other gold stocks, Agnico-Eagle ( AEM) and Eldorado Gold ( EGO) were trading lower at $40.56 and $15.57, respectively.

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-- Written by Alix Steel in New York.

>To contact the writer of this article, click here: Alix Steel.

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