Spot gold rallied more than 1 percent and U.S. gold futures as much as 4 percent on Tuesday, snapping four consecutive sessions of losses as a weaker dollar helped battered commodities stage a comeback.
Euro-zone officials are working to magnify the firepower of the region's rescue fund, European Central Bank policymakers said on Monday, boosting hopes the region will be able to staunch a sovereign debt crisis that threatens the world economy.
The news pushed the dollar down 0.5 percent against a currency basket , making gold cheaper for holders of other currencies.
Spot gold gained 1.5 percent to $1,651 an ounce by 0708 GMT, after sinking as much as 7 percent to a 7-1/2-month low near $1,530 on Monday.
U.S. gold rose 3.7 percent to $1,653, headed for its biggest one-day rise since March 2009.
In the last couple of days the market over-reacted to the situation in the euro zone and the U.S., said Cameron Alexander, senior metals analyst at GFMS, a unit of Thomson Reuters.
Gold's appeal as a safe-haven asset remains intact given the uncertainty in global growth and concerns about Europe's sovereign debt, and strong investment demand is likely to push gold towards $2,000 by the end of the year, said Alexander.
Technical indicators suggested gold could see more short-term weakness. Spot gold may fall back to Monday's intraday low of $1,534.49 later in the day, said Reuters market analyst Wang Tao, who is looking for even larger falls in the long term.
Investors are eyeing a key vote in the German parliament on Thursday to approve changes to the European Financial Stability Facility rescue fund.
There may be another leg lower in gold, as people position themselves ahead of the EFSF votes in case there was a good outcome that would lead to a sell-off in the dollar and rising risk appetite, said a Singapore-based trader.
Holdings of the world's largest gold-backed exchange-traded fund, SPDR Gold Trust , fell 0.4 percent to 1,246.762 tonnes by Sept. 26, after standing unchanged for four sessions.
Physical buying has increased over the past week or so, as spot gold prices sank nearly 10 percent in the past four sessions.
At the current level people are buying, because they believed what happened in the past few days was only a correction, said Ronald Leung, a physical dealer at Lee Cheong Gold Dealers in Hong Kong.
The premium on gold bars in Hong Kong had risen to more than $2 per ounce above spot prices, as a result of increased demand, he added.
Other precious metals also rebounded from Monday's trough. Spot silver rallied 3.8 percent to $31.81, before easing slightly to $31.46.
U.S. silver jumped as much as 6.4 percent to a high of $31.88, and remains on course for its biggest one-day rise in two and a half months.