Gold tumbled to a two-week low on Friday as diminishing liquidity concerns prompted a bout of selling, but lingering concern about financial stability and strong physical buying interest from Asia later helped it to recover.

Spot gold hit $1,761.94 a troy ounce, its lowest since August 26. It was bid at $1,787.10 an ounce at 1058 GMT compared with $1,788.64 late in New York on Thursday.

Gold started its decline after major central banks' coordinated to ease liquidity constraints on Thursday, which raised cautious hopes that policymakers would announce further action to help support the system.

Yesterday's announcement has taken away some stress out of the market, said Walter de Wet, analyst at Standard Bank.

U.S. banks have been reluctant to lend dollars to their counterparts in Europe because of the debt crisis.

A shortage of dollars has meant frozen money markets, which if it continues could hit economic growth as most international trade is carried out in dollars.

But gold has rebounded nicely from its lows this morning, we've seen fairly decent buying out of Asia, de Wet said.

Over the past couple of weeks whenever gold falls below $1,800, we've seen good buying, especially in Shanghai.

Traders say the premium for physical over spot in Shanghai was at about $14 compared with normal levels of about $2-$3.

Also a factor behind the morning rally was buying by euro-based investors worried about debt default in the euro zone.

We view the latest correction in gold as temporary, Deutsche Bank said in a note.

Gold and silver prices will keep on rising in an environment where concerns towards the global banking system remain, in our view.

NEED DOLLARS

A weaker euro against the dollar as a result of the debt crisis would normally prompt sales of gold, which typically moves in the opposite direction to the U.S. currency. But that premise was swept away Friday morning, traders say.

Gold priced in dollars was last at 1,287 euros from levels near 1,271.27 earlier on Friday. It hit a record near 1,374 euros earlier this week.

So long as investors worry about Eurozone sovereign exposure, there will be fear of undercapitalisation amongst banks and risk will likely trade on a heavy note and the euro will suffer accordingly, UBS said in a note.

Receding worries about the liquidity crisis helped boost equity markets, but analysts say investors still favoured cash, often even at the expense of gold.

The requirement for cash is back. There's evidence of people lending gold in the swap market to raise dollars, a precious metals trader said.

People are definitely putting a premium on liquidity ... they are choosing to put as much money as they can in cash and other assets including gold will be liquidated.

Investors are also taking profits on gold positions to pay for losses in other markets.

Spot silver was bid at $40.03 an ounce from $39.83 late on Thursday and palladium at $734.60 from $720.75.

Platinum hit $1,762.28 an ounce, its lowest since August 11, as the crisis reinforced worries about the health of global economic growth and demand for autocatalysts.

Spot platinum was bid at $1,803.74 an ounce from $1,781.38 on Thursday.