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* Gold set for largest three-day fall in 28 years
* Flight to cash prompts widespread selling
By Amanda Cooper
LONDON, Sept 26 (Reuters) - Gold fell on Monday, buckling under the weight of the strength of the dollar as investors scrambled for cash in the face of mounting fear over the impact of a potential Greek debt default on the euro zone economy.
Euro zone officials played down reports on Monday of emerging plans to halve Greece's debts and recapitalise European banks to cope with the fallout, stressing that no such scheme is yet on the table.
European equities rose on the back of hopes of a prompt solution to the debt crisis, while industrial commodities such as silver and base metals bore the brunt of investor desire for liquidity in the face of mounting uncertainty and a stronger dollar.
In the last three days alone, gold has fallen by over 10 percent in its largest three-day slide in 28-1/2 years, having lost more than 20 percent since hitting record highs just shy of $2,000 an ounce earlier this month.
Spot gold was last down 4.0 percent on the day at $1,589.84 an ounce by 1415 GMT, having fallen earlier by as much as 7.4 percent, putting the difference between the intraday high and low at $128.40, the largest daily price swing on record.
"It's got things going for it now clearly sovereign risk hasn't gone away. So for gold, as outright insurance, that demand is still there. Where we are struggling at the moment is gold is still sensitive to the dollar," said Citigroup analyst Jon Bergteil.
"Backing off away from $2,000 under the weight of those issues have not really at the moment led to an immediate long term sell-off," Bergteil said, adding: "What we will require for that is for people to stop worrying about sovereign risk, that they come to the conclusion that the world is going to grow very nicely and we will not face these pot holes."
After a weekend of being told by the United States, China and other countries that they must get more aggressive in their crisis response, European officials focused on ways to beef up their existing 440 billion-euro rescue fund.
Deep differences remained over whether the European Central Bank should commit more of its massive resources to shoring up Europe's banks and help struggling euro zone member countries.
The lack of consensus on a lasting solution to the euro zone debt crisis has been a major driver in this year's rise in the gold price to record highs above $1,900 an ounce.
"The rise in volatility taking place in the gold price was clearly an indication that gold was no longer a low-risk asset. So there are a few signs there that would have given you pause for thought, but inevitably when the move happens, everyone is taken a little bit by surprise," said Natixis commodities strategist Nic Brown.
"I would suggest that part of what is happening is a collective move away from commodities by investors. The fact that there is carnage going on across the commodities spectrum indicates there are a fair few investors who are getting cold feet at this stage and that has hit some precious metals disproportionately," he said.
Last week's data on investment in U.S. gold futures shows speculators cut their holdings to their lowest level in over two years, as reflected by the fall in net non-commercial open interest on COMEX. <0#CFTC>
Short-term interest rates on dollars and other major currencies, have shot up this month, as banks have become increasingly unwilling to extend funding to each other because of fears over their individual exposure to the debt of the peripheral euro zone nations.
Gold is often sold off as a means of raising dollars when funding conditions deteriorate, much as they did in late 2008 with the onset of the credit crunch that ensued from banks withholding lending because of their concern over counterparty exposure to toxic U.S. mortgage-backed assets.
"Gold is one of the few assets that remains in positive territory this year, in a sense it is one of the last assets standing, and because of this as investors head for cash they sell the assets that have performed. Essentially gold is a victim of its own success as liquidity trumps," wrote UBS analyst Edel Tully in a note.
Silver also came under fire, falling by as much as 16 percent at one point in the day and set for its worst three-day fall on record, having lost more than 25 percent in this period.
The spot price was last down 9.1 percent at $28.22 an ounce, its lowest since last November.
Platinum fell by 4.2 percent to $1,538.49 an ounce, its lowest since May last year, while palladium recovered from an earlier 5.0-percent fall to trade down 1.1 percent on the day at $624.50 an ounce, around its lowest since last October. (Editing by James Jukwey)