Gold spiked up more than 2 percent in Europe to a 10-week high on Tuesday as rising oil prices fuelled 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 rose to $940.00/941.00 an ounce at 1458 GMT from $925.95/927.15 in New York late on Monday. Earlier, it touched a session high of $944.90, its strongest level since April 18.

"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.

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.

High oil prices are fuelling 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 fuelling buying of gold as a safe haven.  The FTSEEurofirst 300 index was down 1.7 percent at 1403 GMT, while US stocks opened lower on Tuesday on concerns over rising oil prices and the outlook for financial stocks.

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

However, it has since given up those gains and is trading little changed on the day. 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 US 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 an average $895 an ounce, against its previous forecast for $851, citing rising oil prices and the sluggish recovery of the US 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. - Reuters