* Gold set for third straight weekly drop, biggest since
March
* Fed outlook and dollar strength weigh on precious metals
* GRAPHIC-2016 asset returns: reut.rs/1WAiOSC
(Updates prices, adds comment)
By Jan Harvey
LONDON, May 20 (Reuters) - Gold edged higher on Friday after
two days of losses but remained on track for its biggest weekly
slide in nearly two months on growing expectations for an
increase in U.S. interest rates as soon as next month.
Spot gold was up 0.2 percent at $1,257.11 an ounce at
1345 GMT, while U.S. gold futures for June delivery were
up $3.30 at $1,258.10. Spot prices are down 1.5 percent this
week and facing a third straight week of losses.
New York Fed President William Dudley said on Thursday there
was a strong sense among central bank officials that markets
were underestimating the probability of policy tightening.
That came a day after the minutes of the Fed's April meeting
revealed that most policymakers felt a rate increase might be
appropriate as early as next month, sending gold to a three-week
low of $1,244. It has since bounced back, as ultra-low yields
and concerns over economic growth lent support.
"In a negative gold environment, gold prices would have been
much lower after these Fed comments overnight," ABN Amro analyst
Georgette Boele said. "The fact that we are around current
levels is a sign that investors are buying on dips and see
weakness as an opportunity."
Gold is highly sensitive to interest rates, gains in which
lift the opportunity cost of holding non-yielding bullion. The
metal has rallied 18 percent this year as investors bet the Fed
would hold off from further increases.
The dollar retreated from its highest in nearly two months
against a currency basket, but was heading for a third week of
gains, keeping up pressure on gold.
"The gold environment now is substantially different from
what was apparent several weeks ago, when a weaker dollar and a
benign rate environment were providing an element of support,"
INTL FCStone said in a report. "This is no longer the case."
Holdings of the world's largest gold-backed exchange-traded
fund, SPDR Gold Shares, rose by 4.5 tonnes on Thursday to
their highest since November 2013.
Gold demand in Asia was subdued this week by a firmer dollar
and weak seasonal demand in major trading centres.
Among other precious metals, silver was up 0.6
percent at $16.57, while platinum was up 1.5 percent at
$1,024.40 and palladium 2.1 percent higher at $566.10.
Palladium was the biggest faller of the week, down 4.7
percent. A deepening deficit in the palladium market this year
was predicted by industry experts gathered for Platinum Week in
London.
(Additional reporting by Koustav Samanta and Vijaykumar Vedala
in Bengaluru; Editing by David Goodman and David Evans)