Gold prices fell on Tuesday for the first time in seven days as buyers stayed on the sidelines ahead of the U.S. Federal Reserve policy meeting, which could signal new monetary stimulus, a move that will likely power the metal's recent rally.

Bullion snapped a seven-day rally, which was underpinned by safe-haven bids on signs of a worsening euro zone debt crisis. Spain on Tuesday had to pay a euro-era record price to sell short-term debt, underlying the region's troubles run much deeper than Greece.

Gold option volatility fell for a second straight day, suggesting some investors do not anticipate big price moves in the metal. The drop also tracked a similar decline in the equities options fear gauge VIX .VIX as Wall Street rallied 1 percent on encouraging U.S. housing data.

Gold's appeal as a hedge against economic uncertainty could also rise when the Fed issues its policy statement at the end of a two-day meeting on Wednesday. Economists said the U.S. central bank could extend its effort to drive down borrowing costs instead of committing to a new stimulus program.

Gold has shown itself to be very sensitive to shifts in expectations of U.S. monetary policy. If the Fed states that it is prepared to ease policy further if the economy should weaken, this may be sufficient to support gold prices, said James Steel, chief commodity analyst at HSBC.

Spot gold was down 0.4 percent at $1,622.18 by 1:49 p.m. EDT (1749 GMT). Prior to Tuesday, the metal had gained around 3 percent during its seven-day winning streak.

U.S. gold futures for August delivery settled down $3.80 an ounce at $1,623.20. Trading volume was weak for a second straight day, preliminary Reuters data showed.

Poor U.S. jobs data early this month prompted talk the Fed could be pushed into a third round of quantitative easing (QE3).

Clearly the shift towards easier money is much more necessary now than it was three months ago. That's good news for gold, Adrian Day, president of Adrian Day Asset Management, said.

Given a U.S. outlook that is weak but not recessionary, the Fed could opt for extending Operation Twist, its effort to drive down long-term borrowing costs by selling short-term securities to buy longer-term ones.

ETF DEMAND UP AHEAD OF FED

Interest from longer-term gold investors appears improving before the Federal Reserve Open Market Committee (FOMC). Bullion held by the world's largest gold exchange-traded fund, the SPDR Gold Trust, rose by 3 ton, or 0.3 percent, to 1,281.6 ton, its highest level since late April.

The metal had rallied as much as 15 percent after the Fed in January said it would keep interest rates near zero until at least late 2014. Gold has since tumbled several times, however, after Fed Chairman Ben Bernanke mentioned no further easing in his congressional testimonies.

Year to date, gold is up about 4 percent. The market is still a long way off the record seen last year at $1,920.30 an ounce.

Among other precious metals, silver was down 0.8 percent at $28.48 an ounce, while spot platinum edged up 0.3 percent at $1,480.25 an ounce, and spot palladium inched up 5 cents at $627.13 an ounce.

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