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Barring a rebound of unprecedented scale, the price of gold is set to notch its first annual decline in 13 years and its biggest drop since 1981. Gold is down 29% year-to-date.
On its way up, gold attracted legions of investors large and small, including big-name hedge-fund managers such as Paulson & Co.'s John Paulson, Greenlight Capital Inc.'s David Einhorn and Third Point LLC's Dan Loeb. They bet that the Federal Reserve's extraordinary stimulus launched after the financial crisis would weaken the dollar and stoke inflation, raising gold's value as a form of protection.
Many investors got burned this year when Fed officials began to hint at scaling back the central bank's bond-buying program designed to boost growth. Inflation had remained subdued even after the Fed pumped more than $3 trillion into the economy. The dollar weakened in 2009 and much of 2011 but strengthened again.
The Fed's decision on Wednesday to begin trimming bond purchases further undermined an investing thesis that was already on precarious ground, market experts say.
Gold prices on Thursday fell 3.3% to $1,195 an ounce, the lowest close since August 2010.
"The reasons to own gold have just evaporated," said Jeffrey Sherman, commodities portfolio manager with DoubleLine Capital LP, a Los Angeles money manager that oversees $53 billion. Mr. Sherman said DoubleLine sold its gold holdings at a loss after a steep drop in prices this past spring.
Other fund managers are exiting as well. Third Point sold a long-held gold position in the second quarter. Earlier this month, hedge funds and other money managers as a group held the smallest bet on rising gold prices since 2007, according to data from the U.S. Commodity Futures Trading Commission.
Representatives for Third Point and Greenlight Capital declined to comment.
Mr. Paulson is one of the most high-profile casualties of gold's selloff. Known for reaping billions from wagers against the housing market, Mr. Paulson started a gold fund in January 2010 when the metal was trading around $1,100 an ounce and marching higher. He even offered investors in other funds shares that were denominated in gold.
Mr. Paulson's gold fund is down 63% this year through October, according to documents presented at his annual investor day last month. The fund managed $370 million as of last month compared with about $1 billion near the start of the year.
The firm, however, added in the materials that its "thesis remains intact" and that it considered 2013 a "pause mode" in a long-term upward trend. A representative for Paulson declined to comment on Wednesday.
While many hedge funds took a hit from gold's fall, money managers who invest with decades in mind, not quarters, see the decline as reason for optimism.
"You've had this watershed moment," said Sameer Samana, a senior international strategist with Wells Fargo Advisors. "The economy's starting to firm. Instead of inflation expectations ticking higher and interest rates lower, the opposite is going on. That's really gotten the steam to come out of gold."
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Gold hit its all-time high of $1,888.70 an ounce in August 2011, when investors were digesting a European debt crisis, the unprecedented downgrade of the U.S.'s credit rating and the prospect of another round of bond-buying from the Fed.
Roaring stock markets have further dimmed gold's appeal as a haven. The Dow Jones Industrial Average reached a new high on Thursday and shares in Europe and Japan have posted double-digit gains this year.
While gold prices increased steadily starting in 2001, the rally accelerated in the wake of the financial crisis. After the collapse of Lehman Brothers Holdings Inc., central banks began to take drastic measures to forestall a collapse of the financial system. Gold prices doubled in the following three years.
The financial innovation in the 2000s that helped bring gold into the mainstream also has played a role in the metal's downfall. Gold ownership for investment purposes essentially was prohibited in the U.S. between 1933 and 1974. After their introduction in the U.S. in 2004, exchange-traded funds became among the most popular tools investors used to buy gold.
The amount of gold held by ETFs is down 30% this year as investors shifted to stocks and other assets. Analysts say the ETF selling helped accelerate gold's downward spiral.
While gold is down, few investors think it is going to be relegated to the fringe of financial markets anytime soon.
After buying gold became easier, some wealth-management advisers began recommending that investors hold a small percentage of their portfolios in gold as part of a diversification strategy.
Institutional investors from pension funds to university endowments bought gold.
Some are holding on.
"I look at gold purely as a hedge" against declines in currencies, said Scott Malpass, chief investment officer with the University of Notre Dame's investment office. Mr. Malpass said the fund had sold some of its gold in recent years as prices rose, but that it has no immediate plans to cash out entirely. The endowment holds less than 0.5% of its $8.7 billion in assets in gold bars, Mr. Malpass said.
Some retail investors also haven't lost faith. The U.S. Mint's gold-coin sales to dealers, a measure of retail investors' appetite, was up 29% in the first 11 months of the year compared with the same period in 2012.
Robert Gordon, president of a real-estate settlement business in Leesburg, Va., was among the retail investors who saw this year's decline as a buying opportunity.
"For years we've been saying the chickens will come home to roost" in the form of higher inflation, he said. "Eventually someone has to pay the piper."
Still, gold prices are widely expected to remain under pressure as the Fed unwinds its crisis-fighting measures. Credit Suisse analysts, who were among the market watchers who said 2013 would mark the end of gold's streak, named a bet on lower gold prices as their top raw-materials trade for 2014.
Famed commodity investor Jim Rogers says he is keeping the gold he owns, but has entered into derivatives contracts to guard against declines in the value of the metal. "I wouldn't buy gold right now under any circumstances," Mr. Rogers says.
—Rob Copeland and Gregory Zuckerman contributed to this article.

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