Gold recovers as oil firms, dollar off highs

LONDON (Reuters) - Gold recovered on Tuesday after the previous session's sharp sell-off as oil rose for the third straight day and the dollar eased from highs against the euro.

Rising crude prices typically underpin gold, which is often bought as a hedge against oil-led inflation.

Gold rose to $888.20/889.20 an ounce at 5:43 a.m. EDT from $882.85/884.05 in the U.S. market late on Monday.

"We had a nice bounce as Europe opened. That was mostly driven by crude, which jumped higher as we started trading," said Tom Kendall, an analyst at Mitsubishi.

"Certainly that bit of a recovery in the euro and easing back in the dollar has helped as well," he added.

Bullion prices shed almost 3 percent on Monday to their lowest level in nearly a week as a bounce in the dollar against the euro sparked a spate of fund selling.

A stronger dollar often pressures gold, which is bought as an alternative investment to the U.S. currency.

Rumors that a hedge fund liquidated about 2 million ounces of gold also contributed to the losses, according to some dealers.

Appetite for gold is muted, however, ahead of the rate-setting meeting of the Federal Reserve starting Tuesday, which is expected to give fresh impetus to the dollar.

Traders widely expect the Fed's Open Market Committee to leave interest rates on hold at 2 percent. However, they will be closely watching the FOMC's accompanying statement for clues as to their future bias towards rates.

"Gold is likely to take its cue from the Fed statement," said HSBC analyst Jim Steel in a note.

"Fed Chairman Ben Bernanke and other Fed officials stepped up their flow of hawkish rhetoric in recent weeks, and it stands to reason... that at least some of this rhetoric will appear in this week's FOMC statement."

If the market takes the statement as a signal a hike in rates is imminent, it could support the dollar, pressuring gold.

Investment demand remained firm on Monday, with the amount of bullion held by the world's largest gold-backed exchange-traded fund, New York's SPDR Gold Trust, rising by 2 percent or 12.26 tonnes to 628.21 tonnes.

However, the volume of silver held in the iShares Silver Trust, the largest silver-backed ETF listed in the United States, slipped by 46.2 tonnes, or three-quarters of one percentage point, to 5,971.63 tonnes on Monday.

The fund's silver holdings are now at their lowest since May 13.