By Sethuraman N R and Arpan Varghese
(Reuters) - While an imminent hike in U.S. interest rates is putting a downdraft on gold prices, bullion's allure as a safe haven is likely to limit the downside, traders and analysts say, owing to uncertainties in the United States and Europe.
Gold slumped to a 10-month low in mid-December after rates were increased for the first time in a year, but gold investors don't appear to be as jittery ahead of the next Fed meeting and a near-certain rate rise on March 14-15.
The previous slide came also as equity investors cheered the election of U.S. President Donald Trump, but gold has since recovered about 7 percent on a lack of clarity on Trump's policies and worries about upcoming elections in Europe.
"The expectations of rate hikes are already priced into gold unless the expectations grow to four hikes, which we think is unwarranted," said analyst Dominic Schnider of UBS Wealth Management in Hong Kong.
"With a more hawkish Fed, there is no incentive to chase gold. But, the disappointment potential on President Donald Trump is very high. The Congress will not give what he wants."
Higher interest rates make it less attractive to hold non-interest bearing gold, while a firmer U.S. dollar also makes gold more expensive for buyers in other currencies.
Gold has fallen about 5 percent from a three-month peak on Feb. 24 to $1,198 an ounce, but traders say the risks of a sharp technical fall have eased and expect physical demand to emerge in a band from $1,150 to $1,200 an ounce.
"From the fund management industry, some people believe in this political uncertainty trend, and they are buyers of gold," said Hans Brandt, commodity fund manager at Swisscanto Invest.
"Some believe economic growth is picking up, the dollar is getting stronger over the next 3-6 months. Those people are sellers at this level."
LONG POSITIONS RISE
Speculative long positions held by hedge funds and money managers in COMEX gold have nearly tripled this year, suggesting a fresh round of allocations into gold in 2017.
However, the 121,720 lots at Feb. 28 were still less than half of the 286,921 contracts held in July 2016, when speculative fever was at its peak as gold prices hit over 2-year highs at $1,374.91 an ounce.
This lower amassed speculator position reduces the threat of a sharp drop in prices should a flood of speculative positions be unwound, said Commerzbank (DE:CBKG) analyst Carsten Fritsch.
Increasing inflation across a number of major economies will also likely dampen appetite for fixed income investments and support gold, said UBS's Schnider.
"There is interest in physical gold if prices drop below $1,200. People will definitely see value below $1,200 and that will help stabilize the market. So far, ETFs also have looked resilient," Schnider said.
Physical gold holdings in exchange-traded funds have fallen since last week, partly because of a stronger dollar, but at 54.45 million ounces are still nearly 3 percent higher than at the start of February. Holdings are also roughly 6 million ounces or 13 percent above where they were in early March 2016.
Meanwhile, gold is expected to be boosted by political risks stemming from Britain's exit from the EU and upcoming contentious elections elsewhere in Europe.
"The impact of a Fed rate hike will be offset as we go into the French elections. This year, we also have German, Dutch and Italian elections and all have the possibility of surprises," INTL FCStone analyst Edward Meir said.
"We saw very good physical demand when prices came near $1,150. Especially, the German public is very keen on buying. Nobody is talking about interest rates there," said Michael Kempinski, Managing Director, Degussa Precious Metals Asia Pte. Ltd.
"People in Europe face uncertainty every day ... when prices come down, they buy more."