Gold rose nearly one percent on Tuesday as strong Asian physical demand and bargain hunting after three straight sessions of losses lifted bullion prices to $1,660 an ounce.
News that the Bank of Japan will consider easing monetary policy again in January in a bid to ease deflation worries underpinned gold's appeal as a hedge against inflation, traders said.
Investor sentiment remains cautious after minutes from the December meeting of the Federal Open Market Committee showed several top officials favored slowing or stopping the stimulus program "well before" the end of the year.
"Gold could certainly test its $1,625 support again,with prices drifting materially below the $1,600 mark if there is more talk of an early stop to QE (quantitative easing) in the coming days," said Bart Melek, head of commodity strategy at TD Bank.
Successive rounds of QE, or printing new money to boost asset prices, have been a primary driver of higher gold prices in recent years.The move has put downward pressure on long-term U.S. interest rates and fuel inflation fears.
The presence of a large number of short-term investors who had bought gold on U.S. "cliff" worries could also trigger a sharp price drop if investors headed towards a quick exit, Melek said.
Spot gold was up 0.8 percent at $1,660.20 an ounce. U.S. gold futures for December delivery settled up $15.90 an ounce at $1,662.20.Trading volume was about 5 percent above its 30-day average, preliminary Reuters data showed.
Gold has dropped over 2 percent in the last three sessions on fears that the U.S. central bank may halt its bullion-friendly asset purchases. Analysts, however, are skeptical about Tuesday's rally.
VTB Capital analyst Andrey Kryuchenkov said that it does not appear gold's gains would last due to jitters ahead of Thursday's ECB monthly bulletin which provides the central bank's latest economic assessment.
Asian Buying Picks Up
Gold-buying in Asia in particular rose after prices dropped to a 4-1/2 month low last week, with the trading volume on the Shanghai Gold Exchange's 99.99 gold physical contract hitting record levels on Monday.
The premium of Shanghai's 99.99 gold over spot prices was also increasing, traders said. The Hong Kong Census and Statistics Department said on Tuesday that Hong Kong exported 90.763 ton of gold to mainland China in November, up 91 percent on the month.
In addition, premiums on gold shipments to India jumped to their highest in two months on Tuesday.