Gold settled at $1,336 on Monday, surging nearly 3 percent as a technical breakout above $1,300 an ounce triggered a rush by funds and speculators to buy back their bearish bets.
The metal is on track to post its biggest three-day rally in over a year, partly boosted by heavy short-covering as futures investors rolled over to December from August deliveries ahead of first-notice day next week. Silver also surged around 6 percent.
(Read more: Bernanke doesn't understand gold, should we?)
"With more shorts being built over the last couple of months, it's not surprising to see that the shorts have to cover their positions with the increase of prices," said Carols Sanchez, director of commodities and asset management at CPM Group.
However, the removal of short-term catalysts such as short-covering and contract rollover and possible renewed bearish bets by funds suggest bullion prices could come under pressure, analysts said. Further tightening of gold import rules by India's central bank could also weigh heavily on physical demand by the world's largest gold consumer.
Spot gold was up 2.9 percent at $1,333 an ounce after hitting a high of $1,334.76, its loftiest price since June 20. U.S. gold futures for August delivery gained $43.10 an ounce to settle at $1,336.00, up 3.3 percent on the day.
Silver rallied 5 percent to $20.43. Gold is now set for a rally of 4.5 percent since Thursday, its biggest three-day gain since June 1, 2012. Last week, gold posted its second consecutive weekly gain after Federal Reserve chief Ben Bernanke assured investors that the U.S. central bank will be careful in tapering its economic stimulus.
(Read more: China liberalizes bank lending rates in reform push)
The market is still down 23 percent this year and languishes in bear territory. Speculators added almost 2,000 lots to their already record short position in the week to July 16, taking the total to over 80,100 lots, a report by the Commodity Futures Trading Commission showed on Friday.
Even so, with a short position of that size and prices showing signs of steadying after the heavy selling in recent months, prices may stage brief rallies if speculative investors decide to cover some of their shorts, dealers said.
Analysts have slashed their 2013 gold and silver price forecasts after sharp falls earlier this year and expect them to remain weak in 2014 as the United States reins in monetary stimulus, a Reuters poll showed on Monday.