Gold ends up on inflation fear

LONDON (Reuters) - Gold ended sharply higher after surging to a 10-week high on Tuesday as rising oil prices fueled buying of the precious metal as an inflation hedge.

Weak stock markets also increased gold's appeal as an alternative investment, further buoying prices, traders said.

Gold XAU= was at $938.40/939.40 by New York's last quote at 2:15 p.m. EDT (1815 GMT) from $925.95/927.15 in New York late on Monday. It touched a session high of $945.80, its strongest level since April 17.

"Oil is strong," said Commerzbank trader Michael Kempinski, adding that inflation is a continuing worry.

"There has also been a bit of safe-haven buying as the European stock markets have crashed," he added.

The U.S. gold contract for August delivery GCQ8 on the COMEX division of the New York Mercantile Exchange settled up $16.20, or 1.8 percent, at $944.50 an ounce.

The August futures have now gained $73.30, or nearly 8 percent, from a session low of $875.20 on June 25.

Oil prices resumed their move higher, trading up more than $3 a barrel at their session high on Tuesday after a report from the International Energy Agency forecast oil supply would remain tight.

However, U.S. oil futures ended just 97 cents higher at $140.97 a barrel.

High oil prices are fueling fears of inflation, against which gold is often bought as a hedge. Strength in oil also tends to stimulate interest in commodities as an asset class.

Equity market weakness is also fueling buying of gold as a safe haven.

The FTSEEurofirst 300 index .FTEU3 ended sharply lower, while U.S. stocks retraced early losses in late trade as better-than-expected auto sales improved momentum.

Meanwhile the dollar was steady against the euro for much of the day, before strengthening after a report showed U.S. manufacturing activity was stronger than expected in June.

However, the U.S. currency has since given up those gains and is trading lower against the euro.

Traders are also looking ahead to the European Central Bank's upcoming decision on interest rates, due Thursday. Speculation over interest rates on both sides of the Atlantic has had a significant impact on gold.

"The outlook for prices increasingly relies on the U.S. dollar, interest rates and perceptions about whether the FOMC has the intestinal fortitude to lift rates in the August/September window," said JP Morgan analyst Michael Jansen.

"The market has recently cast more doubt about the Fed's inflation fighting credentials following the release of the FOMC statement last week, and this in turn has allowed the gold price to move materially higher."

Investment bank UBS said on Monday it was raising its average gold price forecast for 2008 to $895 an ounce, against its previous forecast of $851, citing rising oil prices and the sluggish recovery of the U.S. dollar.

It also upped its outlook for silver to $17.00 from $15.76, for platinum to $2,010 from $1,853 and for palladium to $460 from $370. It raised its projected price of rhodium for the full year to $9,413 from $7,794.

In fundamental news, the ECB said on Tuesday it completed gold sales of 30 tons on June 30, and added that it had no plans to sell more gold in this year of the agreement, which runs until September.

Among other precious metals, spot platinum XPT= was little changed at $2,069.00/2,089.00 an ounce from $2,060.00/2,080.00 late in New York on Monday.

The metal is benefiting from expectations a smelter shutdown at major platinum producer Lonmin will affect supply.

Spot palladium XPD= was slightly lower at $464.00/472.00 an ounce against its Monday finish of $459.00/467.00, while silver XAG= rose to $18.09/18.14 an ounce from $17.38/17.43 late in New York on Monday.

(Additional reporting by Frank Tang in New York; editing by Jim Marshall)