Oil prices dropped $4 a barrel yesterday and the stock market posted its biggest one-day gain in 10 months as financial markets responded to a weekend of relatively encouraging news about the Persian Gulf crisis.

Reports that U.N. Secretary General Javier Perez de Cuellar is about to undertake a mediation mission with Iraq and that the Organization of Petroleum Exporting Countries is apparently ready to ratify an increase in its oil production shored up investor optimism and eased fears of an oil shortage.

The price of crude oil for October delivery closed at $26.91 a barrel in trading on the New York Mercantile Exchange -- a decline of $4 from yesterday's opening price. The drop was immediately reflected in sharp declines in the wholesale price for gasoline and home heating oil.

Traders and market analysts warned that the markets remain extremely volatile and will respond negatively to any increase of tension in the Middle East. And partly as a result of the recent bad news from the Persian Gulf, consumer confidence in the nation's economy has now dropped to its lowest level since the early 1980s, according to a survey. {Details on Page G1.}

Wall Street's strong showing yesterday -- the Dow Jones industrial average rose 78 points -- followed rallies of similar proportion earlier in the day on the Japanese and West German exchanges.

Today in Tokyo, shares on the Nikkei stock average rose 2 percent by the close of morning trading, and the U.S. dollar fell to a seven-month low against the Japanese yen.

The Dow rose 78.71 points yesterday to close at 2611.63 for its best one-day performance since Oct. 16, when it rose 88.12 points. Stocks of smaller, less well-known companies performed even better than the blue chips.

The market soared so quickly at the opening bell -- more than 50 points in the first nine minutes -- that it triggered a recently adopted mechanism on the New York Stock Exchange that helps to slow the rise and fall in prices.

While the encouraging news from the Middle East sparked yesterday's stock rally, analysts said investors also were lured into the market by the bargain prices that resulted from a three-week sell-off that had cut the Dow average by nearly 15 percent.

"People had made a sort of indiscriminate sweep of their portfolios," and that caused many stocks to be "brought down to what we consider to be pretty reasonable levels" for buying, said David Rajala, director of equity management at One Federal Asset Management Inc., a Boston-based firm that manages $3 billion.

Bond prices also rallied, causing yields to fall. The Treasury's benchmark 30-year bond rebounded nearly $16 dollars per $1,000 in face amount. Its yield, which on Friday reached its highest point since April 12, 1989, at 9.15 percent, fell back to 8.99 percent.

And confirming the general sense that world tensions had eased, the price of an ounce of gold -- considered by many to be the safest investment in times of trouble -- dropped $26.70 on the New York Commodity Exchange from Friday's close.

The only weakness on financial markets yesterday was registered by the dollar, which continued its descent, hitting yet another postwar low against the German mark.

Despite the glittering gains yesterday, analysts were skeptical that the rally on financial markets could sustain its upward momentum for long. Instead, many saw the rally -- which began with a gain on Friday -- as a largely technical rebound caused primarily by a reaction to recent heavy selling.

"I don't think there was any dramatic change in anything fundamental underlying the market," said Claudia E. Mott, a quantitative analyst at Prudential-Bache Securities Inc. in New York.

Oil specialists were similarly cautious. "I think the range of $25 to $35 {per barrel} is where the market is going to spend the next few weeks," said Michael Lynch, an analyst at Washington International Energy Group. "But I think the price is going to go up tomorrow."

The price decline was actually overdue, said Arnold E. Safer, president of the Energy Futures Group in Bethesda. "We knew last week that the Saudis were going to increase their production, but the market didn't take that into account last Thursday and Friday."

Safer said oil companies that had been holding on to crude stocks to see where prices were going released some of the oil for sale last week in the belief that prices had peaked. The availability of that oil contributed to yesterday's price drop, he said.

Lynch said that if Iraqi leader Saddam Hussein is "the 300-pound gorilla of the battlefield, Saudi Arabia is the 500-pound gorilla of oil." OPEC ministers meeting in Vienna, he said, are "just looking for a polite way to authorize the Saudis to do what they are going to do anyway" -- increase output by up to 2 million barrels a day to partially offset the 4.45 million barrels a day lost to world markets because of the shutdown of Iraq and Kuwait.

Delegates in Vienna said Saudi Arabia, with help from Venezuela, had rounded up as many as 10 of the 13 OPEC members to support an endorsement of the kingdom's plan to increase production.

Saudi Arabia, Venezuela and the United Arab Emirates have signaled that they are likely to go ahead with increased output regardless of the outcome of the consultations in Vienna, but they would clearly prefer to have approval from their fellow producers. Some OPEC members have voiced resentment over their belief that the Saudis are responding to U.S. political pressure for some action to lower oil prices.

Iran's oil minister, Gholamreza Aqazadeh, signaled the possibility of compromise when he told reporters he was not opposed in principle to an increase in production, though he maintained it was not needed until later in the year, once existing inventories have been drawn down. Special correspondent Michael Z. Wise contributed to this report from Vienna.