* Saudi Arabia cuts ties with Iran, China data disappoints
* Dollar turns higher against basket of major currencies
* Palladium falls 4 pct
* GRAPHIC-Gold vs currencies: http://link.reuters.com/cyv95s (Updates prices; adds comment, second byline, NEW YORK dateline)
By Marcy Nicholson and Jan Harvey
NEW YORK/LONDON, Jan 4 (Reuters) - Gold rallied 2 percent to a four-week high on Monday, buoyed by rising tensions in the Middle East and a sharp drop in stocks following weak Chinese data that fueled concerns over global growth.
Palladium, which as a largely industrial metal is more exposed than gold to economic weakness, dropped sharply, however, after Chinese manufacturing surveys undermined any hopes for a recovery in the sector.
Spot gold XAU= was up 1.4 percent at $1,074.80 an ounce at 2:09 p.m. EST (1909 GMT), after rising to a four-week high at $1,083.30, while U.S. gold futures GCv1 for February delivery settled up 1.4 percent at $1,075.20 an ounce. Spot gold is currently on track for its biggest one-day rise in a month.
The metal initially rallied along with oil after Saudi Arabia cut diplomatic ties with Iran. urn:newsml:reuters.com:*:nL8N14N01H
"The main driver here is the tension between Saudi Arabia and Iran, and the escalating conflict between these two countries," Commerzbank (DE:CBKG) analyst Daniel Briesemann said.
"Weak Chinese data, coupled with plunging stock markets, is probably also playing a role, but geopolitical tensions are the main thing here."
A 7 percent drop in Chinese shares on Monday halted trading in Shanghai and dragged down stock markets around the world, as investors began 2016 with fresh worries over global growth and sought the safety of bonds and gold. MKTS/GLOB
"Gold is up on increased credit risk and on China," said Anthem Blanchard, chief executive of Anthem Vault, precious metals dealer in Las Vegas, Nevada.
"When you have a huge exit out of Chinese stock markets and all that value being sold, it makes a lot of sense that a lot of value is going to go to gold."
Bullion prices came off their highs as oil futures turned negative and the U.S. dollar .DXY extended gains in volatile dealings. O/R
The paring of gold prices also coincided with a comment by San Francisco Federal Reserve President John Williams, who said three to five U.S. interest rate hikes this year would be reasonable. urn:newsml:reuters.com:*:nL1N14O12O urn:newsml:reuters.com:*:nW1N10S00W
Higher interest rates dent demand for non-interest-paying gold, while supporting the dollar.
"With index rebalancing probably taking place over the next couple of weeks, we may see some shifting of investment flows back into gold as an underperforming asset," Mitsubishi analyst Jonathan Butler said.
Assets of the top gold-backed exchange-traded fund, SPDR Gold Shares GLD , fell 0.18 percent to 642.37 tonnes on Thursday, close to a seven-year low.
Silver XAG= was up 0.5 percent at $13.86 an ounce, while platinum XPT= was down 1.1 percent at $880 an ounce. Palladium XPD= was down 4.1 percent at $538 an ounce.