Gold heads for biggest weekly drop in nearly two years

By Jan Harvey

LONDON (Reuters) - Gold recovered some ground to trade more than 1 percent higher on Friday after earlier hitting near-three-year lows, but stayed on track for its biggest weekly drop in almost two years after the U.S. Federal Reserve signalled an end to easy money.

The precious metal rebounded as world shares, bonds and commodities steadied on Friday, a day after a sharp sell-off triggered by plans by the Federal Reserve to cut back its quantitative easing programme.

But that did little to offset Thursday's 5.4 percent price crash. Gold is down 7 percent since last Friday, its biggest weekly drop since it fell from record highs in September 2011.

Spot gold was up 1.3 percent at $1,294.76 an ounce at 1350 GMT, having earlier hit its lowest since September 2010 at $1,268.89 an ounce.

"Bullion will seek to consolidate near current lows, but there is little chance for a sustained rebound," VTB Capital analyst Andrey Kryuchenkov said. "We had little evidence of physical buying -- spooked market participants will stay away.

"Inflation is subdued, seasonal Asian demand is yet to pick up, the greenback is stronger, the opportunity cost of holding gold will start gaining soon," he said. "Given the macro recovery, equities will still perform better -- bullion is not trading as a safe haven asset. Why hold it at all?"

U.S. gold futures for August delivery were up $8.70 an ounce at $1,294.90, having earlier touched a near three-year low at $1,268.70.

The CME Group Inc , parent of the Chicago Board of Trade, raised initial margins for Comex gold after prices plunged to their lowest in three years on Thursday. Comex gold futures fell 6.4 percent in heavy volumes.

The prospect of QE being withdrawn is pushing investors away from gold, analysts said.

"The effects of QE had been hugely positive for precious metals because they weakened the dollar and pushed medium-term interest rates to abnormally low levels, which removed most of the negative carry associated with holding gold," Natixis analyst Nic Brown said.

GRAPHICS:

2013 asset returns: https://bsmedia.business-standard.comlink.reuters.com/dub25t

Gold/silver ratio: http://link.reuters.com/kuq35s

PHYSICAL GOLD FUNDS SEE OUTFLOWS

Holdings of physically backed gold exchange-traded funds - a popular way to invest in bullion since the financial crisis - have fallen more than 485 tonnes this year.

The largest, New York's SPDR Gold Trust, reported another 4.5-tonne drop in its holdings on Thursday, taking them to their lowest in more than four years at 995.35 tonnes, 26 percent below their December 2012 peak of 1,353 tonnes.

Buying in number one consumer India remained muted despite Thursday's price drop, in contrast to the heavy buying seen after gold's April sell-off. Gold in rupee terms remains well above April's lows after the Indian currency fell to record lows against the dollar.

"Demand is not so much, as prices in rupee terms have not fallen due to rupee depreciation," Mayank Khemka, managing director of trading house Khemka Group, said.

Traders reported an uptick in demand from China, the world's second-largest consumer of gold, however.

Silver also dropped to its lowest since September 2010 at $19.35, before recovering to $19.92 an ounce, up 2 percent.

Spot platinum was up 0.2 percent at $1,359.74 an ounce, while spot palladium was the biggest riser, up 1.3 percent at $669.75 an ounce.

(Additional reporting by Siddesh Mayenkar in Mumbai; editing by William Hardy and Keiron Henderson)