NEW YORK (Reuters) - US stocks rose yesterday as a drop in oil prices fueled investor optimism about consumer spending, driving shares of transportation and retailers sharply higher.

US oil prices tumbled 3.5 percent to $131.93 a barrel on the prospect of lower demand from China, which announced it would raise domestic gasoline and diesel prices. That eased fears about the toll of higher fuel costs on American consumers and businesses.

Top technology shares such as Intel Corp rose as investors piled back into chip stocks on the view that they were oversold in recent weeks.

The Philadelphia Stock Exchange Semiconductor Index, rose 2.6 percent, erasing about half of its more than five percent loss in the past two weeks.

Big retailers such as Home Depot rose 2.4 percent.

The beaten-down airline sector saw its second-best day of the year, with several industry leaders like American Airlines' parent AMR Corp soaring more than 15 percent on the New York Stock Exchange.

"When oil is going down, consumers have to spend less money on gas, so they have more money in their pocket for discretionary purposes," said Mark Schlarbuam, head trader at Global Capital Management in Conshohocken, Pennsylvania.

"That helps the consumer discretionary sectors, which include retailers, home builders and especially transport which is extremely sensitive to the price of oil, which is their biggest cost."

The Dow Jones industrial average closed up 34.03 points, or 0.28 percent, at 12,063.09.

The Standard & Poor's 500 Index ended up 5.02 points, or 0.38 percent, at 1,342.83. The Nasdaq Composite Index finished up 32.36 points, or 1.33 percent, at 2,462.07.

Among retailers, home improvement chain Home Depot shares rose 2.37 percent to $27.18. The S&P retail index rose two percent.

Among soaring airlines, AMR Corp rose 85 cents to $6.31. Delta Air Lines climbed 17 percent to $6.38; United Airlines owner UAL Corp jumped 23.8 percent to $8,11 and Continental Airlines surged 16.0 percent to $15.59.

Shares of aircraft maker Boeing Co. rallied 3.1 percent to $76.95, making it the top-weighted gainer on the Dow.

But Citigroup shares fell 1.1 percent to $20.17 after its chief financial officer, Gary Crittenden, told investors that it could have substantial write-downs on sub-prime mortgages in the second quarter.

Rival Bank of America fell 0.8 percent to $28.14.

But insurer American International Group rallied 4.9 percent to $33.07, helped by an upgrade from Citigroup, making it the No.2 weighted gainer on the Dow.

Trading was moderate on the NYSE, with about 1.29 billion shares changing hands, well below last year's estimated daily average of roughly 1.90 billion.

On Nasdaq, about 2.28 billion shares traded, above last year's daily average of 2.17 billion.

Advancers barely edged out decliners on the NYSE. On Nasdaq, advancing stocks beat decliners by a ratio of four-to-three.