Gold futures closed sharply lower Thursday, after news of a terror plot against air flights from the U.K. to the U.S. sent oil futures sharply lower and the U.S. dollar higher.

Gold for December delivery closed down $16 at $646 an ounce on the New York Mercantile Exchange.

"With oil dropping over a dollar a barrel and the U.S. dollar rallying after recent steep losses, gold did not have the buying interest to find its way past the supply as it approached the spot $650-$655 area," said Peter Spina, chief investment strategist at GoldSeek.com.

J.P. Morgan analyst John Bridges said gold was 'misbehaving' because investors appear to have decided that the terror threat "has apparently been defused, the gold insurance can be foregone for a while, and they can refocus on summer holidays."

"We believe this highlights the complacency and short-term nature of much investment," Bridges said.

The Security authorities in the U.K. arrested up to 21 people and halted flights to Europe and the U.S. after foiling a plot to blow up as many as six airplanes. The plot revolved around bringing liquids that could explode on board planes through hand baggage. All those arrested were U.K. nationals of Asian descent, reports said.

The Associated Press reported, citing unnamed U.S. counterterrorism sources, that flights from Continental Airlines were targeted.

Britain's national security threat level was raised to "critical" from "severe." The U.S. government raised its threat level for commercial flights to Britain to its highest level and the U.S. Department of Homeland Security warned that "we cannot be sure that the threat has been entirely eliminated." See full story.

Department of Homeland Security Secretary Michael Chertoff said the plot bore the hallmarks of an al-Qaida attack, but that it was too early to be sure. For now, there is no indication of a plot within the U.S., he said at a news conference.

But the plan was well-advanced and involved sophisticated devices, he said. Air travelers are banned from taking any liquids or gels onto U.S. airplanes and air marshals have been sent to London to expand security, he said. See full story.

The dollar gained against its major rivals, with help from data showing the trade deficit narrowed in June and from its safe-haven status. See Currencies.

Meanwhile, oil prices fell as the terror scare raised concerns of a slowdown in air travel. See Futures Movers.

Kevin Kerr, editor of Global Resources Trader, a newsletter published by MarketWatch, said gold's move was puzzling as it should have benefit from its traditional safe-haven role.

"The news is coming in so fast and furious that traders are almost in shock and are getting their bearings and deciding what to do next," he said.

Kerr said he expects the metal to rally once the gravity of the situation has set in and investors turn to the metal as a safe-haven instrument.

"We see $700 gold as a major possibility should these events escalate," Kerr said.

In the latest news from the Middle East, Israeli troops seized the Lebanese town of Marjayoun as they pushed further into Lebanon, the BBC reported, citing eyewitness accounts. A Lebanese general in the area, however, denied the reports. The town is roughly 6 miles from the Israeli border.

The expanded ground offensive is an attempt by Israel to curb rocket attacks by militant Lebanese group Hezbollah. Israel is also using its fire power to pressure Hezbollah into releasing two Israeli soldiers it kidnapped in July. The abductions are behind the current flare-up in violence.

The United Nations, meanwhile, continues to work on redrafting a resolution calling for a ceasefire. An initial text raised objections from the Arab League as it omitted a demand for an immediate Israeli withdrawal from Lebanon.

Other metals were also lower. Silver futures ended down 46.5 cents at $12.105 an ounce, platinum was down $12.50 at $1,250.50 an ounce and palladium shed $3.95 to $322.75 an ounce.

Copper futures lost 8.55 cents to $3.6245 a pound.

On the supply side, gold inventories rose by 157,434 troy ounces to 8.32 million as of late Wednesday, according to Nymex data.

Silver supplies rose by 583,003 troy ounces to 101.4 million and copper supplies were unchanged at 6,756 short tons.

Indexes tracking mining and metals stocks suffered the same fate as the underlying commodities.

The Amex Gold Bugs slid 2.3% to 336.57 and the CBOE Gold Index slumped 2.5% to 145.61.

The Philadelphia Gold and Silver Index dropped 2.3% to 144.72.