Gold posted its biggest gains in eight weeks on Friday, gaining nearly 2 per cent as the prospect of unrest in Egypt spreading across the Middle East fueled a rush of safe-haven buying in the financial markets.

The nearly $40-an-ounce jump in active trading revived investor interest in bullion, which is still set for its first monthly decline in half a year after investors fled the market on signs that the Euro zone debt crisis was receding and the US economy was on a firmer recovery footing.

After several days of unprecedented protests, the sight of armored cars in the streets of Cairo on Friday finally got the attention of global markets. Oil spiked by more than 4 per cent, the dollar rose sharply and Treasuries gained as investors feared the political instability could spread.

'Confusion breeds contempt for all investments other than gold. Clearly, money is flowing to gold as the ultimate safe haven ... because nobody knows how this situation is going to resolve itself,' said Dennis Gartman, publisher of the Gartman Letter, a daily investment commentary.

Gartman, a long-time gold bull who liquidated some of his position this month, said he did not expect Egypt's unrest to be over anytime soon and that gold could further benefit from the possibility of chaos spreading to other countries in the region.

Spot gold rose 2 per cent to $1,338.39 an ounce by 2:43 p.m. EST (1943 GMT), the largest one-day gain since early December.

That reversed Thursday's 2.6 per cent slump as a run of better-than-expected economic data fueled concern over higher interest rates that could end gold's long bull run.

Earlier in the session, gold touched a four-month low of $1,308.00 an ounce.

US gold futures for February delivery settled up $22.3 at $1,340.70 an ounce, with total volume topping 300,000 lots for a second day running, the highest since November.

Spot silver rose 3.5 per cent to $27.82 an ounce.

Despite Friday's rally, gold notched a four-week losing streak, its longest consecutive weekly decline in a year.

After the toppling of Tunisia's president earlier this month, financial markets are even more on edge over growing instability in the Middle East as Egyptian President Hosni Mubarak attempts to quell street fighting and mass protests demanding an end to his 30-year rule.

'The market is a little sensitive when people take to the streets as it reminds them of the riots in Greece a year ago, and that did lead to a flight into the safety of US Treasuries,' said Chris Rupkey, chief financial economist at Bank of Tokyo/Mitsubishi UFJ in New York.

The dollar index rose 0.5 per cent and US Treasuries climbed. Stocks fell around the world while many other key commodities gained, led by oil which jumped to nearly $100 a barrel in London.

Investor exodus

Gold initially weakened after data showed the US economy gathered speed in the fourth quarter with the biggest gain in consumer spending in more than four years.

Latest trade data by the Commodity Futures Trading Commission (CFTC) showed that open interest, a gauge of market liquidity, sank 14 per cent to just above 500,000 lots as speculators cut their net longs or bullish positions for a third week.

Open interest fell sharply after hedge fund SHK Asset Management liquidated a US gold futures position this week valued at over $850 million, more than 10 per cent of the main US futures market, the Wall Street Journal reported.

Investment demand for gold has been soft this year, with holdings of the SPDR Gold Trust, the world's largest gold-backed exchange-traded fund, down another 3 tonnes on Thursday.

Holdings of the world's largest silver-backed ETF, the iShares Silver Trust, also fell on Thursday.

Some analysts said the confluence of selling from gold and silver ETFs and futures showed the characteristics of capitulation, and prices should rebound after a large number of investors exited their bullish positions.

Gartman said liquidation pressure in gold had run its course after spot prices bounced off key support near their 150-day average in overnight trade.

Platinum climbed 0.7 per cent to $1,793.50 an ounce and palladium gained 1.1 per cent to $810.72. – Reuters