Gold shorts send metal to key $1,200

Short-covering boosted gold futures above the key $1,200 level, but a strong dollar and worries about global deflation could keep gains in check.

On the first day of December, gold rose to its best level since late October, after taking a major roller-coaster ride overnight.

Gold dipped low enough—to the $1,141 per ounce zone—to attract new buying, after the failure of a Swiss referendum Sunday that would have required the Swiss National Bank to hold 20 percent of its reserves in gold.

Comex gold futures for February erased those losses and hit $1221 per ounce, before settling with a gain of 3.6 percent at $1,218.10—its biggest intraday swing April, 2013. Silver futures were also extremely volatile, rising to $16.47 per ounce.

On the plus side, the Indian government Friday withdrew a rule requiring traders to export 20 percent of the gold imported into the country. India instituted the rule and gold tariffs in an effort to rein in its current account deficit.

Read MoreIndia eases gold import rule in surprise move

"We didn't think that (Swiss) vote was going to pass. Nobody thought that, but they've cleared the air," said George Gero of RBC. "What brought gold back was there are three continents that have to stimulate their economies. We not only saw softness in Europe with the PMIs, we saw softness in Japan."

He said China also had softer PMI overnight, and the U.S. report of disappointing Black Friday weekend sales was also a sign of weakness. "All of that means more stimulus and that means more inflation coming. Oil also has rebounded from the lows," he said.

Jim Steel, chief commodities analyst at HSBC, said the Indian government move is important for gold, but its not enough to ignite a massive rally.

"They didn't wipe the tariffs away, but it is the first or second-largest consumer, depending on the year so what they do is important," he said.

Steel said the market is being pulled by emerging markets buyers hunting for bargains, but then pushed back by the headwinds of the stronger dollar and deflation.

The drop after the Swiss vote brought in buyers but he said the euro will have to gain strength for the rally to go much further.

Gero said the current rally could continue, and he sees the next target for the market at $1,225 per ounce.