Jewellery demand buoys gold but dollar a risk

Gold, a key player in the commodities boom earlier in the year, has turned in recent weeks into one of its most visible losers.

Prices slid 17 percent in the last four weeks to a nine-month low of $773.90 an ounce on Friday as a firmer dollar, falling oil prices and losses in industrial precious metals such as silver and platinum weighed on the market.

They have since ticked back up, hitting $817.80 on Wednesday, as physical demand rebounded and the dollar retreated. But risks to the precious metal remain if the greenback firms again.

"While the dollar is strong, that could well point to more declines to come in gold," said UBS strategist John Reade.

Gold is often bought as an alternative investment to the dollar and a hedge against currency weakness, and typically moves in the opposite direction to the U.S. currency.

The dollar has been boosted by weak economic indicators from the euro zone in particular, which have fuelled fears the U.S. economic slowdown is spreading to other areas of the globe.

While the outlook for the U.S. and the dollar are murky, traders are concerned other currencies could fare even worse. Just as the dollar's weakness boosted gold earlier in the year, its recent move up has pushed the precious metal lower.

The firmer dollar has pulled gold more than 25 percent from its all-time high of $1,030.80 an ounce it hit in March, and its rise appears to be hitting investor interest in gold.

Data released by the U.S. Commodity Futures Trading Commission last Friday showed open interest in the gold futures market has shrunk as investors cut their commitments to buy.

ETF outflows

Gold held by the world's largest gold-backed exchange-traded fund, New York's SPDR Gold Trust, has fallen by more than 50 tonnes since their all-time high in mid June.

The trust saw a 1 percent outflow in its gold holdings on Aug. 19, its first in nearly two weeks.

ETFs are trusts that issue securities backed by physical commodities. ETF investment has been a major source of demand for gold in recent years, but investors fear if funds start selling their gold stocks in earnest, spot prices could fall.

"One big thing for the gold market is what the ETFs will do," said Commerzbank senior trader Michael Kempinski. "If they are patient and believe in the (market) we could see upside again. But if they don't, I'm really sceptical."

A dip in oil prices, which have also slipped sharply from record highs, is also weighing on the market.

However, despite the gloom that descended on the market last week as precious metals plummeted, gold has managed to steady.

Traders say demand from jewellers, which suffered from high and volatile gold prices, is coming back into the market.

"We are seeing very large physical demand," said Afshin Nabavi, head of trading at MKS Finance in Switzerland. "If we didn't have this physical demand, I think gold would be much, much lower."

The dip in the SPDR Gold Trust notwithstanding, the volume of gold held by ETFs in general has also remained relatively stable. London's ETF Securities said holdings of its Physical Gold ETF rose to a record 1.800 million ounces last week.

Nonetheless, if more ETF sales are seen in gold, the dollar's upward move finds further traction and oil prices keep falling, the metal is likely to struggle to hold its ground.