Gold rose around one percent on Monday as the U.S. fiscal impasse remained unresolved, but was still not far from three-month lows on speculation an eleventh hour solution to the debt crisis will be found.
Senate negotiations to resolve the U.S. fiscal crisis made progress on Sunday and, while there are no guarantees of an end to the government shutdown, many in the market believe a deal to raise the borrowing ceiling will emerge.
Congress has until Oct. 17 to raise the debt ceiling, or risk defaulting.
"There has been some short-covering today... but overall, the market is expecting a U.S. debt ceiling agreement eventually and it is mostly positioning a little bit more on the short side rather than the long," MKS SA head of trading Afshin Nabavi said.
"If there is a deal however we may not have a big move down, as this seems to have very much been discounted."
Spot gold rose 1.2 percent to a session high of $1,288.88 an ounce earlier and was trading up 0.9 percent to $1,284.47 an ounce by 1407 GMT.
U.S. gold futures for December were up $16.80 an ounce at $1,285.00.
Bullion fell to its lowest since July 10 at $1,262.14 an ounce on Friday, after more than 3 million ounces changed hands on the Comex December futures contract in just 15 minutes, prompting a near $30 drop in prices and a brief trading halt.
Gold has not seen a lot of safe-haven bidding over the last two weeks, when parts of the U.S. government have been shut down due to the budget impasse.
Instead, prices have been hurt by large sell orders, amplified by technical selling. Earlier this month, another big trade sent prices lower by $25 an ounce in a short period of time.
With no Commitment of Traders report on Friday, due to the U.S. government shutdown, it is difficult to gauge the extent of speculative positioning and whether the move that began early last week is driven by the short or long side, ANZ said in a note.
"We view that long liquidation would be much more harmful to sentiment."
The last time high tension emerged over talks to lift the U.S. debt ceiling, in 2011, gold hit record highs. This year, sentiment towards bullion is much less positive, analysts said.
The metal has lost nearly a quarter of its value this year on expectations the U.S. Federal Reserve will soon end its stimulus programme, which has kept interest rates low and stoked inflation fears.
Many in the market now expect the Fed to begin stimulus tapering only after the uncertainties over the U.S. budget are resolved.
As a gauge of investor sentiment, holdings in SPDR Gold Trust, the world's largest gold-backed exchange-traded fund, fell 5.40 tonnes to 890.98 tonnes on Friday.
Silver rose 1.5 percent to $21.51 an ounce. The metal posted a 2.4 percent weekly loss, its worst in four weeks.
Spot platinum was up 1.4 percent at $1,382.50 an ounce. Spot palladium rose 0.2 percent to $712.97 an ounce.
China's car sales totaled 1.59 million vehicles last month, up 21 percent from the year earlier, Friday's data showed. China's car market favours gasoline-powered engines, which use heavy palladium loadings in their catalysts. (