U.S. dollar prices for buying gold rose briefly above $1,600 per ounce Tuesday morning before falling back, while silver failed to hold above $29 an ounce and stock markets fell following the inconclusive Italian election result.
Italian markets were especially affected, with stocks and government bonds seeing sell-offs, while on the currency markets the Euro hovered near seven-week lows against the Dollar following yesterday's 2% drop.
"Risk sentiment turned negative [this morning] on the inconclusive Italian election and fears of sustained instability for the country and Eurozone as a whole," says a note from Credit Agricole.
"The outcome of the Italian elections is likely to spark increased demand for gold," adds a note from Commerzbank, "as it could force the sovereign debt crisis back into the foreground."
Italy's general election failed to produce a clear winner, with the bloc led by Pierluigi Bersani's Democratic Party winning the lower house of parliament but failing to win the Italian Senate.
The biggest share of the lower house vote to go to a single party went to the Five Star Movement, a protest movement led by comedian Beppe Grillo, which polled 25.55%. Grillo and Five Star have campaigned against the austerity measures brought in by outgoing technocrat Prime Minister Mario Monti, whose party only polled around 10% of the vote for each house of parliament.
Bersani's bloc will have more seats than Five Star, however, as will the bloc led by former Prime Minister Silvio Berlusconi's party. Berlusconi is expected to win the region of Lombardy, according to Italian television, which adds that this should give him control over the upper house.
"The political situation across Europe is effectively a race between austerity and reforms on the one hand and the rise of populist movements on the other," says Alberto Gallo, head of European macro credit research at Royal Bank of Scotland.
"Austerity is painful, and if reforms are not implemented in time, you run the risk of social unrest and populism. It hasn't happened so far in Greece, it hasn't happened in Portugal or Spain, but we are very close in Italy."
The FTSE MIB, Italy's main stock market, fell 5% from yesterday's close in Tuesday's early trading, while investors also sold Italian government bonds, pushing 10-Year yields to a three month high above 4.9%.
"It's clear that from a foreign investor point of view they're very concerned about political instability and forming a government that can push through pro-growth policies in Italy and in Europe," one Milan-based fund manager told newswire Reuters this morning.
Gold exchange traded funds tracked by news agency Bloomberg meantime saw their holdings fall to a five-month low of 2536.3 tonnes yesterday.
"The latest collapse in gold ETF holdings stands in sharp contrast to our [earlier] assumption that ETF positions were likely driven by longer-term allocation rather than short-term trading," says a note from the commodities research team at Goldman Sachs. "Instead, ETF holdings are increasingly exhibiting a strong inverse correlation to real [inflation-adjusted interest] rates, a pattern that we now expect will continue going forward."
Goldman cut its gold price forecasts, with its 12-month forecast falling from $1,800 an ounce to $1,550 an ounce.
"The decline in prices since last fall and our updated forecast suggests that the turn in the gold price cycle is likely already underway," the report says.
Over in Washington, Federal Reserve chairman Ben Bernanke is due to testify to the Senate Committee on Banking, Housing and Urban affairs later today. Bernanke will then appear before the House of Representatives Committee on Financial Services tomorrow to complete his twice-a-year monetary policy update to Congress.
"Given the Fed['s]...highly dovish bias, we expect them to continue printing into [the third quarter]" says UBS commodity strategist Julien Garren. "[That's] when we in commodity strategy, in contrast to our economists, expect global growth to lose momentum. That sets up a major gold rally in Q3."