Gold slipped in late business on Tuesday as investors took profits from 16-month highs, but sentiment stayed bullish ahead of an expected rate cut by the U.S. Federal Reserve.
The Fed is expected to slash its benchmark 5.25 percent fed funds rate by at least 25 basis points at 1815 GMT on Tuesday to help cushion the U.S. economy from credit market turmoil and a housing market slowdown.
Lower interest rates tend to make the dollar less attractive and often boost gold's appeal as an alternative investment.
It's good to see some consolidation and not just one steep upward pattern, which cannot be maintained, said a precious metals analyst in London.
Everyone is waiting for the Fed decision. In the near term, I am bullish on gold but there has to be a little bit of caution as everyone seems too bullish. It would be really positive for gold if the Fed cuts the rate by 50 basis points today.
Spot gold rose as high as $721.50 an ounce before falling to $713.45/714.15 by 1418 GMT, against $716.80/717.60 late in New York on Monday.
Gold is not far from its 26-year high of $730 an ounce struck in May last year and is roughly $138 below its all-time high of $850, fixed in London on January 21, 1980.
The hedge funds were really disillusioned and they waited until gold found its own direction and when it recovered a little bit and triggered at certain point, they started piling back in. Now suddenly everybody is super-bullish, said Stephen Briggs, economist at SG Corporate and Investment banking.
The Fed decision is important. Until quite recently the market was pricing a very high probability of 50 basis points. Now the market still thinks there is a high probability of 50 basis points, but not as high as it was thinking last week. The bias of the risk is towards the Fed disappointing, he said.
The metal has regained its footing since tumbling to a seven-week low of $641.10 in mid-August, when investors sold gold to raise cash to cover margin calls on losses ignited by a meltdown in the U.S. subprime mortgage market.
Gold was also supported earlier by strong oil prices, which jumped to a record high above $81 a barrel, drawing strength from concerns of a winter supply squeeze in the world's top consumer, the United States.
Gold is used as a hedge against oil-led inflation, while a lower dollar makes gold, denominated in dollars, cheaper for holders of other currencies. Gold is seen as an alternative form of money for investors who are bearish on the U.S. currency.
Whether the current levels can be sustained remains to be seen. But like it or not, gold's proving too tough to be short at the moment, UBS Investment Bank said in a daily report.
In related news, the Bank of Spain planned to sell no more gold this year, Governor Miguel Angel Fernandez Ordonez said. The bank has sold several times so far this year and at the end of August held 9.1 million troy ounces.
In other precious metals, platinum was last quoted at $1,298/1,302 an ounce, against $1,298.30/1,305.30 in New York, while palladium gained to $329/332 from $328.75/332.75. Silver eased to $12.70/12.75 an ounce from $12.75/12.80.