PRECIOUS-Gold recovers from 3-1/2-month low as stocks rise

* Progress in U.S. fiscal talks boosts stocks, euro

* Gold recovers from lowest since Aug. 31 at $1,661/oz

* Indian gold buyers take advantage of price dip

(Updates throughout, changes dateline, pvs SINGAPORE) LONDON, Dec 19 (Reuters) - Gold prices firmed on Wednesday, recovering from the previous session's 3-1/2-month low, as signs of progress in U.S. fiscal talks and well-received German economic data boosted appetite for assets seen as higher risk, like stocks and commodities. European equities reached a new high for the year and world shares hit 17-month peaks on hopes that U.S. politicians will reach a budget deal, while the euro hit a 7-1/2 month high versus the dollar after German business confidence data. Spot gold was up 0.2 percent at $1,672.31 an ounce at 1131 GMT, while U.S. gold futures for February rose $2.90 an ounce to $1,673.70. 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 fuelling the move. Saxo Bank vice president Ole Hansen said he expects gold to retrace back to yesterday's technical breakout at $1,688 today. "With the clear-out seen yesterday, we've seen longs taken out, and that could be a potential turning point. As we turn to next week, we will look ahead instead of backward," he said. 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 '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. U.S. House of Representatives Majority Leader Eric Cantor said he expects a vote on a Republican offer to avert the crisis on Thursday, and he expects to 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. "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. 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, the world's biggest buyer of the metal, took advantage of lower prices to buy, as a 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 7 percent and set for a 12th straight annual growth driven by rock-bottom interest rates, concerns over the financial stability of the euro zone and diversification into bullion by central banks. A 7 percent gain in gold this year would be well below an average return of 16 percent over the past 12 years. Among other precious metals, platinum was up 0.1 percent at $1,592.99 per ounce, and spot palladium was up 0.1 percent to $687.50 per ounce. Silver was down 0.2 percent at $31.57 an ounce.

(Editing by Jan Harvey and Alison Birrane)