Hedge funds, which had built up long positions when the metal pushed through US$435 (HK$3,393) a troy ounce late last week, opted to sell Thursday when gold's momentum stalled as its old foe, the greenback, strengthened.

Despite a now unfavorable short-term technical picture, market watchers say gold's evolving status as a diversifying asset class will continue to limit its downside.

For Jonathan Barratt, foreign exchange and metals director at Sydney-based Tricom Resources, gold has established itself as an inflation fighter.

``People are going to go to gold whatever the global growth story is because, regardless of what happens, inflationary concerns will be with us [and] gold has reinvented itself as an inflation fighter,'' he said.

``If the US story is positive, you have an inflationary story, which is good for gold. If crude pushes through US$60 a barrel, you have cost-push inflation. If [the crude price] comes off to US$35, it promotes growth, and potentially inflation. And if equity prices come off as a result of interest rates moving up, then there is also a move to gold,'' said Barratt.

According to Martin Mayne from Rothschild Australia, funds have been building exposure to gold since 2000 more as a hedge against US dollar weakness rather than inflation.

But both analysts agree gold is established as a small but significant diversifying asset in many portfolios.

``People are in gold. [Their prices] have shored up and as a comparable asset it will still perform, perhaps not as well against the US dollar but certainly against some of the other currencies like the Swiss franc,'' said Barratt.

Another factor supporting gold is the emergence of retail investors, particularly in India and China, as well as via exchange traded funds in New York and London. Just as people have adjusted to US$60-a-barrel crude prices, they are also adjusting to US$420-an-ounce-plus gold levels, according to the bulls.

At the other end of the investor scale, countries with large US dollar reserves, such as China and Japan, may now be more inclined to look at gold as a way of diversifying reserves even as European central banks continue to sell.

Another supporting factor is declining gold production, which is down 4percent last year to its lowest since 1996. And strong producer currencies such as the South African rand and the Australian dollar are keeping costs high, thereby restricting new output.

On the downside, funds tend to restructure portfolios away from nontraditional asset classes like gold at the first sign of trouble since they are traditionally the most volatile. Funds may be easily drawn back toward fixed investments if US rates rise enough, said Mayne.

But the yawning US deficits, with current account funding alone projected to rise to 7 percent of gross domestic product in the coming years, mean the dollar is likely to stay under pressure amid waning demand for US treasuries and bonds, said Alastair McIntyre, precious metals director at Standard Bank London's Hong Kong office.

``The market acts on hints of deficit correction and that's when the dollar will strengthen - it could be next week or next year, but most likely one to two years,'' he said.