Gold steadied with little overall change on Wednesday, after dropping the previous session to a 3-1/2-month low, as encouraging U.S. home building permits data and rising German business morale boosted bullion's inflation-hedge appeal.
Rallies in crude oil and a weaker dollar also helped the metal find a firmer footing after Tuesday's technical sell-off triggered by growing hopes that U.S. legislators are closer to reaching a deal that would avert a fiscal crisis next month.
Selling pressure dried up on Wednesday as President Barack Obama threatened to veto a Republican tax plan as talks to avert a fiscal crisis by the end of the year turned sour despite recent progress.
The uncertainty about the U.S. budget talks has dampened investors' interest in gold. After Tuesday's sell-off, bullion prices are on track to end the quarter down almost 6 percent to match their worst quarterly performance since the third quarter of 2008 at the height of the global economic crisis.
"The attraction of holding gold should wane as any agreement that restores...revenue increases and spending cuts over the next 10 years would be an important step in getting the U.S. fiscal house in order,'' said Edward Meir, metals analyst at brokerage INTL FCStone.
Spot prices hit their lowest since Aug. 31 on Tuesday at $1,661 an ounce, with traders citing a break through key chart levels and activity on the options market as fueling the move.
"There's been a lot of interest in protecting against downside risks,'' Standard Chartered analyst Daniel Smith said, referring to the options-related trading.
Gold has traded closely in line with stocks this year and tends to benefit from weakness in the dollar, which makes assets priced in the U.S.unit cheaper for other currency holders.
But it has struggled to make headway as expectations grew that negotiations to avert the so-called 'fiscal cliff' - $600 billion in spending cuts and tax hikes due next year, which threaten to push the U.S. back into recession - will be successful.
"The macro background is improving, and this is creating headwinds for gold,'' Smith said. "The safe haven appeal of gold is diminishing.''
U.S. House of Representatives Majority Leader Eric Cantor said he expected a vote on a Republican offer to avert the crisis on Thursday and that he would have enough votes to pass the measure.
Analysts say a quick resolution of the fiscal crisis could in the long-term hurt gold, as it would erode the metal's appeal as a haven from risk and boost interest in other assets. (Read More: Even Gold Bull Jim Rogers Is Turning Cautious)
"As the macro environment improves, especially provided the 'fiscal cliff' is avoided, gold investors in developed economies will increasingly look to diversify from bullion and into riskier assets where returns are better,given the ongoing economic recovery and better-than-expected U.S. data,'' VTB Capital said in a note.
"Once again, it will not happen overnight and we still see bullion benefiting from relative dollar weakness next year. (Read More: Is 2013 the Year of $50 Oil and $1,200 Gold?)
He added: "However ... the longevity to the ongoing quantitative easing is set to be increasingly questioned, while bullion is set to start losing its shine to other metals in the precious complex.''