Gold surged 3 per cent and hit a one-month high on Monday, vaulting back over a technical threshold at US$1300 ($1629) an ounce as speculators fearing a reversal of the recent downward price trend rushed to buy back bearish bets.
It was gold's heftiest one-day gain in 13 months and its three-day rally is the biggest in almost two years. Also contributing was heavy short covering as futures investors anticipating the start of delivery period on August contracts rolled positions from August to December. The first day for delivery notices is July 31.
Spot gold was up 3 per cent at US$1334.31 an ounce, after hitting a high of US$1338.91, its loftiest price since June 20. US gold futures for August delivery settled up US$43.10 an ounce to US$1336, with trading volume about 15 per cent above its 30-day average, preliminary Reuters data showed.
Gold has now rallied of 4.6 per cent since Thursday, its biggest three-day gain since October 27, 2011.
"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 Carlos Sanchez, director of commodities and asset management at CPM Group.
Technical buying helped bullion to hold onto its gain after spot gold ended above its 50-day moving average for the first time since November 2012.
However, possible renewed bearish bets by funds combined with India's tightening gold import rules suggest bullion prices could come under pressure, analysts said.
As well as the unwinding of short positions, weaker-than-expected US housing data overnight has also been a factor, said Jordan Eliseo, chief economist at precious metal supplier ABC Bullion.
"It started in early Asian trading and it was probably sparked by a report, which showed that a lot of the short positions that have been in place for gold and that have been at record highs of late have started to unwind. People got nervous and they also started covering their positions and that caused the initial rally up above US$1300.
"There was a continuation overnight off the back of some disappointing US data. Home sales came out worse than expected and a continuation of the weakening trend in US housing since yields started to pick up.
"What we're seeing is a realisation from the market that the Fed cannot taper, or if they do taper, it'll be a long way away from normalised monetary policy and people ... don't want to be short gold anymore."
Eliseo said it was important to remember that gold remained in bearish territory this year. Gold has lost 20.23 per cent this year, while silver has slipped 32.22 per cent.
"It's not that people are getting wildly bullish on gold, they're just not as bearish anymore. But the futures market was so tilted to the short side that even people just removing bearish bets is enough for the price to rally quite strongly," he said.
Last week, gold posted its second consecutive weekly gain after Federal Reserve chief Ben Bernanke assured investors that the US central bank will be careful in scaling back economic stimulus, which slashed US interest rates after the financial crisis and raised interest in gold investments.
The market is still down 23 per cent this year and languishes in bear territory. Speculators added almost 2000 contracts to what was already a record net short position totaling over 80,100 lots in the week to July 16, a report by the Commodity Futures Trading Commission showed on Friday.
Even so, given the size of the short position and signs of prices steadying from months of heavy selling, rallies would not be a surprise if investors move to cover 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.
India's central bank moved to tighten gold imports again on Monday, making them dependent on export volumes with an eye to reducing a record current account deficit. India, the largest gold consuming country, offered relief to domestic sellers by lifting restrictions on credit deals.
"From a personal standpoint, I find it hard to see how the Indian gold market will weather these restrictions," said Rhona O'Connell, head of metal research and forecast at Thomson Reuters GFMS.