One of these bastards cost me a previous character, and my current character took one down without incident. I just ran into another one and decided to play with it.
I found that neither water nor fire work, as a prevention or cure. There's an odd bug that makes you fireproof after your fat is burned off, so you can go back and sit in the flames for awhile, but the rot won't burn away, nor will the infection stop. Shields aren't as reliable as they are against dragon breath, but if you do block it the cloud won't expand your direction.
The kind of demon that can do this is variable; you won't know until it spews that you're facing this attack. Your defenses are variable, even with master dodge and superlegendary shield, it was getting through with a high frequency. Even the expansion rate of the cloud appears to be variable, so evasion tactics also aren't reliable. And there is no remedy. You're right about implying the unfairness of this, Zengrath. I wouldn't mind a challenge at this stage of the game, but this is some meanspirited game design, a straight up fistfuck.
EDIT: No cure, but I've noticed a few things about the cloud. It doesn't expand on the z-axis, so if you can fight one on the side of the mountain, you can go up or down a level as soon as he spews. Also, the cloud expands slower on the diagonals, so if you fight him diagonally, you can outrun the cloud diagonally. It's best to catch him around the corner of an obstacle, or even better inside the mouth of a tunnel, because the breath won't move around the obstructions. If you stay on the ground, he won't charge you and dislodge your position, or knock you off the mountain.
It's not a cure, and you still have to identify the hard way which demons each world can do this.