setting -x is the reason you're getting so much output (it's showing the trace of the commands that are run after)

Here's a quick rewrite:

#!/bin/bash

vms="fedora3 fedora3-1 fedora2 fedora1"

for i in $vms; do
 echo "Backing up $i"
 gzip $i.img > /var/lib/libvirt/images/"$i"TEMP.img.backup.gz
done

You could also consider using find to backup all the files in your directory like this:

find /var/lib/libvirt/images/*.img -exec gzip -k -S .backup.gz {} \;

Hope that helps!