Up to Thursday, gold had lost 4.7% since settling at the record high of $US1,258.30 an ounce on June 18.

Included in that was the nasty fall a week ago yesterday when the price dropped off a cliff and plunged under $US1,200 an ounce before bouncing off $US1,188 an ounce mid-week.

Overnight the price struggled back over $US1,200 an ounce, but it wasn't very convincing.

There seems to be a newly-developed caution in the market about gold pricing as some smarter investors are eyeing the impact of a possible outbreak of deflation in the US and its impact on asset values for a while.

A couple other of bits of news ruffled confidence: first London analysts noticed the Bank of International Settlements had carried a swap with unnamed parties in 2009 covering a large 349 tonnes of gold.

And China's State Administration of Foreign Exchange (or Safe, the keeper of all $US2.4 trillion of the country's reserves) upset the bulls when it said that it did not see the need to make the precious metal a significant part of its asset portfolio.

Given that China set the market running last year when it revealed it had been buying gold for years on the quiet (buying the output of Chinese mines, it seems in some cases), this latest view is seen as negative (or rather, not as bullish as the surprise buying was).

"It cannot become a main channel for investing our foreign exchange reserves," the agency said on Wednesday noting that the size of the gold market was limited and prices were volatile.

Buying more gold would also not help much in diversifying China's reserves.

China has increased its gold holdings by more than 400 tonnes in the past few years to 1,054 tonnes.

Even if it doubled that amount, gold's share of Safe's portfolio would increase by only one or two percentage points.

In fact Safe seems to like Japanese government bonds more than gold and has been buying these with their wallets open in recent months to diversify away from the already overweight position in US dollar debt.

But on the more optimistic side of thinking is GFMS, the well respected London-based metal consultants.

This week it reiterated its forecast for gold to touch $US1,300 an ounce before the end of the year, adding that physical demand should prevent prices falling below $US1,150.

"Even though progress is dependent on yet higher inflows from investors, economic conditions still seem to favour such growth in investment over the balance of this year and, indeed, they probably will continue to do so well into 2011," said Philip Klapwijk, chairman of GFMS.

Speaking in Beijing, Mr Klapwijk, GFMS' chairman, the consultancy expected an increase in supply in 2010 due to the IMF program boosting overall official gold sales (in spite of some buy-side interest elsewhere) and further growth in mine production (albeit by less than 2009's 7% gain) which together would offset a marginal drop in global scrap supply.

On the demand side, he said fabrication demand, which is dominated by jewellery, was forecast to recover some of the ground lost late last year, although year-on-year growth is expected to slow in the second half of 2010 due to higher metal prices.

He said GFMS therefore saw the gold market as remaining in a substantial surplus in 2010.

"With limited scope for de-hedging by producers, the gap between supply and demand will have to be filled by investors, who so far this year have considerably increased their holdings of gold in the form of ETFs and physical bullion.

"In the second half of 2010 GFMS expect investment demand to be volatile but overall to remain on a positive trend due to ongoing concerns about the long-run value of major currencies, particularly in the light of continued ultralow short-term interest rates and the increase in government debt levels.

"In GFMS' view the growth expected, especially in value terms, of investment demand will probably be sufficient to drive prices above the $1,300 mark during the second half.

"This process would be aided by physical markets, to some extent at least, adjusting to higher price levels, as indicated by the rebound in fabrication demand and the drop in global scrap supply in the first half, in spite of considerably higher average US dollar gold prices," GFMS said.

And it warned there remained "scope for (the) downside over the next few months if investment demand temporarily faltered, although in the absence of a major change in the economic outlook, it was felt that gold would now be well supported at prices between $1,150 and $1,200".

"Even though progress is dependent on yet higher inflows from investors, economic conditions still seem to favour such growth in investment over the balance of this year and, indeed, they probably will continue to do so well into 2011.

"Nevertheless, it should be borne in mind that especially with inflation low in all the major economies and given the tough fiscal measures now being introduced in many countries, any serious tightening of monetary policy in the United States and Europe would quickly transform the outlook for investment and the gold price, even if that possibility currently appears rather remote."

The BIS gold swap generated an outbreak of concern in the market Wednesday and Thursday, but that frisson of fear now seems to have died away.

Some dealers saw it as a bull point that the central bankers central bank, as the BIS is known, was prepared to deal in gold (it did similar swaps in the 1960s and 70s, according to analysts).

A popular pick for the other side of the swap was the International Monetary Fund looking to raise cash in 2009 for its various assistance plans to the likes of Hungary or The Ukraine.

Other reports claimed it was unnamed central banks selling their gold to the BIS in a repo deal (there the BIS gives the banks value in exchange for buying it back at a future date, less a 'haircut').

China's comments on gold in its reserves should be viewed with a note of caution.

China will no doubt go on buying gold, as it has been doing for years.

It won't say very much about it and probably said something this week to get out the message that it is not interested in fulfilling some of the grandiose forecasts on price that some bugs have on the basis of unrestricted Chinese purchases of the metal.

That is clearly not going to happen.

But watch the deflationary pressures in the US and Europe, they could be more damaging.