Gold drops on profit taking, posts biggest weekly gain in 2 months

By Frank Tang and Jan Harvey

NEW YORK/LONDON (Reuters) - Gold fell on Friday as investors took profits after the previous session's 3 percent rally on expectations the partial U.S. government shutdown will lead the Federal Reserve to postpone tapering of its bond-buying stimulus.

The precious metal was up more than 3 percent for the week, its biggest weekly gain in two months. Heavy short covering boosted gold prices after the Congress clinched an 11th-hour deal earlier this week to pull the world's biggest economy back from the brink of debt default.

However, gold's upward momentum faded on Friday, partly after data showed holdings in the world's largest bullion exchange-traded fund, SPDR Gold Trust, fell.

"It remains to be seen whether the investor community will now restart their buying of various ETF's given that the Fed's tapering intentions are now merely being postponed," said Edward Meir, metals analyst at brokerage INTL FCStone.

Gold-backed ETF holdings are often seen as a gauge of investor interest.

Spot gold fell 0.4 percent to $1,313.68 an ounce by 1:41 p.m. EDT (1741 GMT).

U.S. Comex gold futures for December delivery settled down $8.40 an ounce at $1,314.60, with volume at just 100,000 lots, about 40 percent below its 30-day average, preliminary Reuters data showed.

The metal leapt 3 percent on Thursday after the deal to re-open the U.S. government and a downgrade to the country's sovereign rating by a Chinese credit rating agency knocked the dollar, prompting a rush among over-extended shorts to cover.

"Once the government re-opened and the agenda moved on from the debt crisis to next week's Federal Reserve meeting, that was a trigger for gold to see some upside," Mitsubishi analyst Jonathan Butler said.

However, in the long run, gold is likely to sell off as soon as talks of Fed tapering resume, Butler said.

Gold's 20 percent drop this year has largely been after Fed Chairman Ben Bernanke signalled earlier this year the central bank's $85 billion monthly bond-buying scheme - which had driven gold higher by keeping a lid on interest rates while stoking inflation fears - will be tapered.

ETF HOLDINGS DROP

Investment interest in gold remained lackluster, as the SPDR Gold Trust reported another 3.3-tonne drop in its holdings on Thursday.

The fund posted a fourth straight week of outflows. Its holdings have fallen more than 35 percent from their December 2012 peak, and are down nearly 3 percent this month.

Among other precious metals, silver edged up 0.1 percent to $21.87 an ounce. Platinum was up 0.1 percent at $1,431.10 an ounce and palladium slipped 0.1 percent to $737.72 an ounce.

(Additional reporting by A. Ananthalakshmi in Singapore; Editing by William Hardy, Pravin Char and Andrew Hay)