Ailing dollar sets gold on track for $1,000 mark

By Jan Harvey and Veronica Brown - Analysis

LONDON (Reuters) - Dollar weakness could prove a boon to gold, pushing prices to new highs for the year above $1,000, as the influence from stock markets and attitudes toward risk wane in favor of its traditional driver.

Last week's dollar tumble saw investors look anew at its fundamentals at a time when gold-specific factors were lacking, leaving the metal to move unfettered through key resistance at $935.50 and hit 8-week highs above $960.

On Wednesday gold was trading around $950 an ounce.

While the currency tried to regain poise, markets have for now cast aside dollar-positive risk aversion to focus on what makes it most vulnerable -- a trillion-dollar-plus U.S. deficit and the impact of unorthodox monetary policy to boost lending.

If the spotlight on weak dollar fundamentals intensifies, gold could find itself in the eye of a perfect storm.

"The dollar/gold relationship will look prominent under two conditions: one is if the dollar is moving around a lot, and the second is if the gold price isn't moving around a lot," said Virtual Metals analyst Matthew Turner.

Bullion's link to the dollar is a well-established one, with the metal traditionally used as a hedge against weakness in the U.S. currency. A softer dollar also makes dollar-priced gold cheaper for holders of other currencies.

That relationship broke down early this year as both assets benefited from a flight to safety among investors. According to Reuters data, gold in fact showed a positive correlation with the dollar of 0.5 in January, as stock market sentiment proved the overriding factor to both.

In May, however, it was back to -0.8, close to a perfect negative correlation of -1.

RECORD HIGHS

The fact that dollar weakness, rather than risk aversion or other factors, was behind gold's rise last week was also shown by the its relative stability when priced in other currencies.

When gold last broke $1,000 in February, it hit record highs priced in euros, sterling, Australian and Canadian dollars. With gold just $40 below that level last week, prices were up only slightly in those currencies.

The outlook for gold therefore looks largely contingent on the path of the dollar over the coming months. With the technical picture now more positive for bullion after last week's gains, fresh dollar weakness could push prices back toward their February highs, analysts say.

"People are fearful again that we could be facing a dollar collapse, which would have severe ramifications across the board," said Calyon metals analyst Robin Bhar.

"All the factors that people have been warning about for several months now seem to be coming to the fore."