Bullion's afternoon gains were fueled by a rally on Wall Street and a slump in the dollar on signs that European leaders were racing to shore up the banking sector, seeking to draw a line under the debt crisis that has rattled marktes.

Mediocre U.S. service-sector and private-employment data that followed grim figures on the euro zone's services sector contributed to choppy trade as investors debated whether bullion was a shelter from turmoil or a speculative bet.

"It's starting to look like gold has finally found some stability as the stock markets around the world have stopped tanking, but that can evaporate in five minutes," said Frank McGhee, a head trader at Integrated Brokerage Services LLC.

Spot gold was up 1 percent at $1,636.79 an ounce by 3:19 p.m. EDT (1919 GMT), off a low of under $1,600.

On Tuesday, bullion fell as much as 3 percent on fears of a potential Greek default and a bleak assessment of the U.S. economy from the Federal Reserve, extending two months of whipsaw trade that has rattled investors.

The correlation between gold and the S&P 500 has been erratic throughout the year. The 25-day log-based correlation was a negative 0.3, suggesting a weak inverse link between bullion and equities. (Graphic: http://r.reuters.com/sef34s)

"When people saw gold's correlation with equities go from inverse to positive, there was more fear that maybe gold has become too frothy in the near term," said Adam Klopfenstein, senior market strategist of futures broker MF Global.

U.S. gold futures for December delivery settled up $25.60 at $1,641.60 an ounce.

COMEX futures volume almost halved the norm, as traders braced for more volatility after gold's sharp pullback from a record above $1,920 an ounce set in September.

Gold's rally was also triggered by broad gains in commodities led by solid gains in crude oil and grains.

"A good portion of gold's gains today was in line with the fact that the dollar was under pressure. We are back to the more traditional dollar weakened, commodities positive relationship," said David Meger, director of metals trading at futures broker Vision Financial Markets.

FURTHER FUND LIQUIDATION POSSIBLE

Independent investor Dennis Gartman said gold's drop on Tuesday below $1,600 an ounce had severely damaged investor psychology.

"We fear that all of the liquidation has not run its course. We fear that one or two or more large hedge funds have yet to be forced from their gold positions," Gartman said.

Even though bullion had dropped as much as 20 percent from its record, gold-backed exchange-traded funds have not seen significant outflows, suggesting ETF investors have played no significant role in the slump, Commerzbank said in a note.

The dollar's decline for a second straight day due to optimism about a potential solution to end the European debt crisis also boosted gold.

Frank Holmes, chief investment officer of U.S. Global Investors, said gold is due a rally after a healthy correction largely driven by a resurgent dollar.

Silver was up 1.1 percent at $30.24, after having fallen as much as 5 percent to a low of $28.40 an ounce.

Spot platinum rose 1.3 percent to $1,482.99 an ounce, while palladium gained 3.5 percent to $568.97 an ounce.