Gold surges 2.5 percent, above $1,700 after Fed

A man melts down gold jewellery in Los Angeles, California August 23, 2011.

NEW YORK/LONDON (Reuters) - Gold surged 2.5 percent on Wednesday to above $1,700 an ounce, its biggest one-day gain in four months, as the U.S. Federal Reserve said interest rates would likely remain near zero into late 2014.

Bullion's rally dwarfed the slight gains in equities and other commodities as the U.S. central bank affirmed views that the pace of U.S. economic recovery remained sluggish.

Investors piled into gold on fears that their portfolio values will shrink due to currency depreciation as global central banks use easy monetary policies to flood markets with cash to boost ailing economies, a fund manager said.

"Ben Bernanke is saying if you keep your money under your mattress you lose out as the purchasing power of the U.S. currency is being eroded," said Axel Merk, portfolio manager of Merk Funds with $750 million in assets under management.

"If you hold gold, the purchasing power is better when all other major currencies are being debased," Merk said.

Benchmark interest rates set by Group of Seven economies currently average 0.5 percent.

The metal also received a boost from the central bank's more sanguine outlook on inflation. It suggested that prices were now rising at a pace consistent with policymakers' goals.

Low interest rates particularly benefit zero-yielding gold, unlike stocks and bonds. Minimal borrowing costs also tend to fuel a gradual increase in commodity prices, supporting the metal's traditional role as a hedge against inflation.

Spot gold was up 2.7 percent at $1,710.44 an ounce by 4:33 p.m. EST (2133 GMT), after rising to a session peak of $1,712.80, its highest since December 12.

U.S. February gold futures settled up $35.60 at $1,700.10 an ounce.

Trading was hectic as volume rose above 300,000 lots, one of the largest turnovers since September and double its 30-day average.

Technical buying also lifted prices after the metal broke above chart resistance at its 100-day moving average for the first time in 1-1/2 months.

Silver rose more than 4 percent on gold's coattails, while U.S. equities measured by the S&P 500 index .SPX and the euro -- with which gold had traded in lockstep in late 2011 -- climbed less than 1 percent.

"From an equity standpoint, it's not a good story as the Fed was anticipating a much slower rate of growth than the market was," said Frank McGhee, head precious metals trader at Integrated Brokerage Services LLC.

"Gold was reacting to the Fed's guidance of historically low rates all the way until 2014, which suggests that there will be plenty of investment money around for an extended period of time," he said.

Gold is up 9 percent for the year after the metal briefly entered a bear market and fell 10 percent in December as the metal appeared to lose its safe-haven status.

COMEX OPTIONS EXPIRE THURSDAY

With the gold market already more choppy than usual at the end of a two-day meeting of the Fed Open Market Committee, Thursday's expiry of February gold options could further increase volatility in the precious metal.

Prior to the FOMC, the gold options market showed that investors would like to protect against downside risk in underlying futures, as most open interest is clustered around puts with lower strike prices.

Put options give the holder the right, but not the obligation, to sell gold at a set price by a set date.

George Gero, vice president of RBC Capital Markets, said Wednesday's gains could be partly attributed to huge short covering ahead of Thursday's option expiration.

Silver rose 4.1 percent on the day to $33.31 an ounce.

Platinum group metals also rose, with platinum up 2 percent at $1,575.85 an ounce, while palladium rose 2 percent to $690.47 an ounce.

(Editing by Dale Hudson, Marguerita Choy and Jim Marshall)