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.''
Renewed Physical Buying
The weakness in the gold price in the past few weeks has triggered renewed physical buying, particularly in Asia, Swiss bank UBS said in a note on Wednesday.
"Our flows to India indicate above-average demand this week and in China, strong volumes continue on the Shanghai Gold Exchange, with the month-to-date daily average turnover at 11,498 kg versus the 12-month rolling average of 7,842 kg,'' it said. "Physical buying out of Europe has also been notable.''
Physical demand from China, which is neck-and-neck with India as the world's top gold consumer, is expected to pick up ahead of the Chinese New Year in February.
Gold importers in India took advantage of lower prices to buy,as stronger rupee helped push gold to a two-week low.
Gold is on track to drop around 5 percent this quarter, its worst performance since the third quarter of 2008 at the height of the global economic crisis.
But for the year, gold is up around seven percent and set for a 12th straight year of growth, driven by rock-bottom interest rates,concerns over the financial stability of the euro zone and diversification into bullion by central banks.
A seven percent gain in gold this year would be well below an average return of 16 percent over the past 12 years.
South Africa wants to impose export curbs on minerals such as platinum and iron ore as part of a drive by the ruling African National Congress to create more jobs in industry in the continent's biggest economy, atop official said on Wednesday.
Silver was down around 1.60 percent to settle below $32 an ounce.