* Investors monitor Cyprus development ahead of weekend
* Spot gold faces strong technical resistance at $1,620/oz
* Coming up: U.S. CFTC commitment of traders data; 1930 GMT (Adds quotes, updates prices)
By Clara Denina
LONDON, March 22 (Reuters) - Gold fell from the previous session's 3-1/2 week high on Friday as Greece agreed to buy out local units of stricken Cypriot banks, but interest in the metal as a safe-haven kept it on track for the biggest weekly gain in two months.
The Mediterranean island is scrambling to avoid a meltdown of its banking system and a possible exit from the euro, with deadline from the European Union of Monday to raise 5.8 billion euros to secure a 10 billion euro ($13 billion) international lifeline.
Gold hit its highest since Feb. 26 on Thursday at $1,616.36 an ounce, as the crisis in Cyprus contributed to lifting the metal out of a downtrend, caused by normalising economic conditions, that took prices last month to their lowest since mid-July.
But prospects for a last-minute deal were capping gains.
"The market has still some confidence that a deal will be reached in Cyprus and that's why gold is retreating," Credit Suisse analyst Karim Cherif said.
"We are still waiting for an outcome on March 25 and that's when we can see more significant price movements, but for now investors are still cautious."
Spot gold was down 0.4 percent on the day at $1,608.31 an ounce by 1401 GMT. The metal was still looking to post its biggest weekly gain in two months.
U.S. gold futures for April delivery traded at $1,606.60, down 0.5 percent.
The metal managed to hold gains in euro terms, posting a 1.8 percent increase so far this week, its strongest performance for more than a month.
Analysts said that a possible deal in Cyprus during the weekend could push gold prices below the $1,600 level again.
"If a deal is struck over the weekend I suspect we will again test the lower portion of the ($1,595 - $1,620) range," MKS Capital said.
But if a bailout agreement is not reached, the metal could again look at piercing resistance at $1,620 an ounce, a price unseen since the end of February, analysts said. A break above that level could also rekindle enthusiasm in trading.
There is considerable pressure from the continuous outflow from gold-backed exchange-traded funds. Holdings of these funds are seen as a barometer of investment interest in gold.
Holdings of SPDR Gold Trust, the world's largest gold ETF, fell 0.902 tonnes from the previous session to 1,221.26 tonnes on March 21, the lowest since July 2011. The fund is headed for a 12th week of outflows.
Asia's physical gold market remained quiet as buyers moved to the sidelines after prices broke above $1,600 earlier this week.
Gold prices faced also pressure from Comex gold options for April, analysts also said.
"In general one would have expected prices to be higher but also there's a lot of interest around $1,600-$1,625 in the option market (ahead of the April expiry), so to some extent you are seeing some technicality to the market too," de Wet said.
In other precious metals, spot silver fell 1.4 percent to $28.74, having reached a one-week high of $29.32 in the previous session. Platinum was unchanged at $1,577.50, while palladium was down 0.2 percent to $751.86. (Editing by Veronica Brown and Anthony Barker)