Gold fell 5% to below $1,690 an ounce on Wednesday for its biggest one-day drop in more than three years, as speculation that central banks might be done with easy monetary policies led funds to exit the bullion trade.
Gold fell nearly $100 and silver was down $3 from session highs. Losses started to snowball at (2030 IST) after US Federal Reserve Chairman Ben Bernanke did not mention another round of monetary easing was imminent.
Trading volume exploded when speculation about an unusually large sell-order ran rampant. Option traders said funds were heavy buyers of puts to protect against further losses.
Gold's losses dwarfed those in the euro and other commodities as bullion fell through key support after it failed to sustain gains around $1,790 an ounce, above Monday's high.
Market talk about erroneous trades in the US Treasury bond futures market also hit sentiment.
Most analysts viewed the sudden decline as an aberration rather than the start of a long-term decline.
"There is no hint from Bernanke's speech that there will be a QE3 type program which people have been hoping for," said Jeffrey Sherman, commodities portfolio manager of DoubleLine Capital, a Los Angeles-based investment manager with $28 billion in assets.
"It's just a pullback, it doesn't feel like it would be the start of a bear market," Sherman said.
Spot gold was down 5% for the day at $1,695.39 an ounce by 4:10 pm, after hitting a one-month low at $1,687.99.
Wednesday's sell-off wiped out gold's gains from earlier in February, and the metal ended the month with a 2.5% loss for its second decline in three months.
Earlier in the session, bullion touched a 3-1/2 month high at $1,790.30 after the European Central Bank completed offering cheap loans worth over half a trillion euros to banks.
The ECB move reinforced some notions among gold investors that central banks might be finished with their monetary easing.
Spot gold fell below its 150-day moving average for the first time in a month.
Analysts said the next important resistance level is $1,650 an ounce, where the metal found support during its last sell-off in late January.
Funds were heavy buyers of December $1,500 put options as some looked to profit and others tried to protect further downside risks in futures, said Jonathan Jossen, a COMEX gold options floor trader.
No Easing Hint from Bernanke
In his semi-annual testimony to the US Congress, Bernanke said that while the decline in the US unemployment rate has been more rapid than expected, it would not continue dropping unless economic growth accelerated.
Bernanke's remarks hit gold particularly hard because heavy bullish bets had been placed leading up to the ECB's offering of low-interest loans as it bought more time to sort out the debt crisis, analysts said.
US gold futures for April delivery settled down $77.10 at $1,711.30 an ounce.
Trading started out quietly but exploded after 10 am EST, with 30,000 lots of the April contract trading in a five-minute span between 10:50 am and 10:55 am.
Turnover was around 340,000 lots, about 70% above the market's 30-day average and on track to be one of the busiest days since September 2011, preliminary Reuters data showed.
Spot silver was down 6.4% at $35.54 an ounce, reversing a 4% gain posted on Tuesday.
Among platinum group metals, platinum was down 2.2% at $1,676.50 an ounce and palladium fell 3.1% to $697.28.