Smith could become the first home-grown champion since Matt Jones in 2019, heading into Sunday two shots behind Danish leader Rasmus Neergaard-Petersen (14 under).
He shares second spot with multiple PGA Tour winner Si Woo Kim of South Korea and Mexican LIV golfer Carlos Ortiz, while Min Woo Lee and Adam Scott are Australia's next best, four off the pace.
Former world No.2 Smith has long spoken about his desire to land the Stonehaven Cup, although that waned over the past three years when the tournament was played as a dual-gender event combined with the women's Open.
The 2022 British Open champion has previously declared the national Open second only to the Masters, as his must-win events.
Highly critical of the change, which he saw as a downgrade, Smith has applauded its return to a traditional format and the selection of famed Royal Melbourne as host for the first time since 1991.
"I love that it's here, I love that it's at Royal Melbourne, I love that it's the Australian Open," Smith said after his third round of five-under 66.
"I couldn't think of a better place to get back into form."
The LIV Golf star has endured a disappointing year, with seven successive missed cuts until this week.
His slump started 12 months ago when he imploded during the second round of the Australian Open, crashing from one off the lead to finish the day eight shots back.
After opening with an eagle on the first at Kingston Heath, Smith hit bogeys on the 10th, 12th and 15th holes, and then a double bogey at the 16th to derail his campaign.
He finished in a tie for 39th.
The 32-year-old said he would have to use is golf smarts and imagination to get the job done on Sunday.
"It's just so many shots that you can hit, that you want to hit, that you just don't need to and can get yourself into trouble," Smith said.
"So smart but really creative, I think around here is key.
"You've just got to play the golf course. I know that sounds very cliched, but there are some golf courses where you can just get out there and hit it at the pin all day and go out there and try and shoot eight or nine under.
"It's just not this place - so just play the right shots and hopefully get yourself in a position to win (over) the last two holes."
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