Spot gold was down 2.1% at $4,198.10 an ounce by 0357 GMT, putting the metal on course for its steepest one-day decline since September 1. US gold futures also fell 2.1% to $4,231 an ounce.
The decline came as investors weighed higher energy prices against the outlook for US monetary policy, with rising oil costs threatening to keep inflation elevated.
"The high bond yields and high oil price tandem continues to act as a thorn in gold’s side. Oil prices have risen on mixed signals about oil flows, which is keeping inflation front and centre for investors," said Tim Waterer, chief market analyst at KCM Trade.
Oil prices moved higher amid uncertainty over supplies and developments involving Iran, the United States and Israel. Iran said diplomacy was the only way to resolve its conflict with Washington and Israel, after US President Donald Trump said he had rejected an Iranian proposal to reopen the Strait of Hormuz and end the fighting.
The developments added to market concerns about energy supplies and the potential inflationary consequences of sustained higher oil prices.
Rate outlook weighs on gold
The Federal Reserve raised its benchmark interest rate earlier this month by a quarter percentage point, bringing its target range to between 3.75% and 4%.
Markets are now closely watching whether the central bank will continue tightening monetary policy. According to CME's FedWatch Tool, traders were pricing in a 68% chance of a US rate hike in October.
Higher interest rates can weigh on gold because the precious metal does not generate interest or other regular income. When bond yields rise, investors may have less incentive to hold non-yielding assets such as gold.
At the same time, higher energy prices can feed inflation by increasing transportation, manufacturing and other business costs, potentially complicating the Federal Reserve's efforts to bring inflation under control.
Gold is traditionally regarded as a hedge against inflation, but that appeal can weaken when interest rates and bond yields rise sharply.
Markets await key US economic data
Investors are also preparing for a busy week of US economic data that could provide further clues about the Federal Reserve's next move.
The economic calendar includes job openings, the ADP employment report, the Personal Consumption Expenditures (PCE) price index and nonfarm payrolls.
The data will be closely watched for signs of whether inflation remains persistent and whether the US labour market is strong enough to support continued monetary tightening.
"Stronger-than-expected inflation or employment numbers could keep upward pressure on bond yields and weigh further on gold," Waterer said.
Cleveland Federal Reserve President Beth Hammack added to the inflation debate on Friday, saying she was concerned that persistently high inflation could cause Americans to become accustomed to elevated prices.
Hammack said the central bank could not allow that to become the norm, underscoring the challenge policymakers face as they balance inflation risks against economic growth and employment.
Other precious metals also fall
The sell-off extended beyond gold, with other precious metals posting significant declines.
Spot silver fell 3.4% to $62.08 an ounce, while platinum dropped 2.7% to $1,730.78. Palladium was also under pressure, losing 2.8% to $1,231.46.
The broad decline reflected a market increasingly focused on the interaction between oil prices, inflation, bond yields and the future path of US interest rates.