Investors have been hoping the Fed will launch another round of quantitative easing
Spot gold rose more than one percent on Thursday, recovering from its biggest fall in more than three years in the previous session when US Federal Reserve Chairman Ben Bernanke failed to signal further monetary easing.
Prices moved up rapidly after the Shanghai Gold Exchange started trading, as investors took advantage of a discount of about US$10 in spot gold to Shanghai prices.
Investors have been hoping the Fed will launch another round of quantitative easing, pushing cheap money into the market that would boost inflation, against which gold is a traditional hedge, and give investors additional firepower to buy bullion.
But Bernanke stopped short of signaling more asset buying in an otherwise dovish testimony in front of Congres, driving down stock markets and boosting the dollar.
While the chances of quantitative easing were reduced, the Fed will likely adopt some measures to promote growth, said Dong Tao, chief regional economist for Credit Suisse in Hong Kong.
"But liquidity will remain the driver of financial markets - this story has not changed, although it will be a fragile story in the sense that markets will be highly volatile."
Spot gold rose 1.4 percent to US$1,719.19 an ounce, rebounding after a five percent fall on Wednesday, its largest one-day loss since December 2008.
The Shanghai gold spot deferred contract stood at 349.30 yuan a gram, or US$1,724.32 an ounce.
US gold gained 0.6 percent to US$1,721.20.
Bullion is still up 10 percent this year, on track for its twelfth annual gain, as interest rates remain low and central banks boost liquidity.
Banks took 530 billion euros of cheap three-year funds from the European Central bank of Wednesday, bringing to over a trillion euros the amount of money the bank has injected into the financial system in two months.
Technical analysis suggested that spot gold's rebound may end at US$1,726 an ounce, said Reuters market analyst Wang Tao.
Gold's long-term outlook remains intact despite Bernanke refraining from indicating further quantitative easing, and a nearly US$100 drop provided a good buying opportunity, traders said.
"It did not sound like a dramatic change, but the market expectations on the QE were too high and prices needed a good correction," said a Tokyo-based trader.
As long as real interest rates stay low gold will remain attractive. In January, the Fed pledged to keep interest rates low until at least 2014, analysts said.
Holdings of physical gold in the SPDR Gold Trust, the world's biggest gold-backed exchange-traded fund, gained 0.7 percent on the day to 1,293.676 tonnes, its highest in two and a half months.
Other precious metals also staged rebounds. Spot silver rose 1.3 percent to US$35.04, after shedding more than 6 percent in the previous session.
Spot platinum climbed 1 percent to US$1,692.74, and spot palladium rebounded 0.7 percent to US$703.25.