Gold prices dropped 2% on Friday, concluding a volatile week of selling, as a lack of confidence in the financial system and a dollar rally triggered heavy liquidation by commodity funds. Gold's status as a hedge against inflation was also weakened as investors fretted that a recession could not be avoided amid a deepening financial crisis. Bruce Dunn, vice president of trading at New Jersey-based Auramet Trading, said gold's drop was due to the dollar's strength and a lack of confidence in the banking system. "It's forced liquidation by the hedge funds that cannot leverage their balance sheets anymore, and they are forced to liquidate positions that they would rather hold," Dunn said. The gold contract for December delivery settled down $16.80, or 2.1%, at $787.70 an ounce on the Comex division of the New York Mercantile Exchange. Strength in the dollar against the euro was being supported by interest in the currency as a haven from risk, analysts said. This was weighing on gold, as it cuts the metal's appeal as an alternative investment to the U.S. currency. "This is a combination of the dollar being stronger, and disillusionment that gold hasn't performed as well as might have been expected (given that) a lot of measures of market turmoil are still showing things to be as bad as ever," said Matthew Turner, analyst at VM Group. Support from gold's other main external driver, crude oil, was also waning. Oil prices jumped nearly $5 a barrel in early trade, but later pared their gains. November crude oil futures settled at $71.85 a barrel, up $2. Rising crude prices boost interest in gold as a hedge against oil-led inflation. A bounce in equity markets, after sharp losses in the previous session, was also likely to cut some call for gold as a haven from risk. U.S. stocks, badly beaten down in recent weeks, were near unchanged late in the day — and European shares ended higher — as investors picked up battered bank shares and firmer oil prices helped energy shares. The world's largest gold-backed exchange traded fund, New York's SPDR Gold Trust, said its bullion holdings slipped more than 1% on Thursday to 756.86. Hundreds of executives, fund managers, traders, analysts and key personnel from the metals industry were in London this week for the annual London Metal Exchange dinner and associated events. Among other precious metals, silver tracked gold lower to $9.36 an ounce, down 2.9 % from Thursday's finish of $9.63. The precious metal slipped sharply on Thursday, falling to a 2 1/2-year low of $9.21.

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