Gold rose toward $1,200 an ounce in Europe on Friday, supported by dollar weakness, as a retreat in risk aversion led to a return of the two assets' usual inverse relationship.

All eyes are on the results of European bank stress tests, due at 1600 GMT. Signs of distress in the sector could lead to fresh interest in gold as a haven from risk, analysts said.

Spot gold was bid at $1,198.35 an ounce at 0940 GMT (5:40 a.m. EDT), against $1,195.35 late in New York on Thursday. U.S. gold futures for August delivery rose $2.40 to $1,198.00.

Post the start of the Greek crisis, gold and the dollar were two classic safe havens, and from then until the last few days, there has been actually a pretty strong positive correlation, said RBS analyst Daniel Major.

Historically, you should get a negative correlation with the dollar and I think that a bit more of a normalization in the risk environment (will lead to that), he said. (Investors) are slightly less concerned about the Armageddon scenario and the double dip, and that is taking the edge off safe-haven flows.

The euro rose 0.3 percent against the dollar after the German Ifo index came in above forecasts, following on from strong euro zone purchasing manager surveys on Thursday. The dollar fell 0.2 percent against a basket of currencies.

Weakness in the U.S. unit usually lifts gold's appeal as an alternative asset and makes dollar-priced commodities cheaper for holders of other currencies.

European shares were positive on Friday, lifted by strength in miners and some banks ahead of the results of European bank stress tests later in the session. .EU

European Central Bank executive board member Jose Manuel Gonzalez-Paramo said on Friday the stress tests, which gauge the health of the EU banking sector, will undoubtedly have a good impact on the banking sector.

But Spanish newspaper El Pais reported that several of Spain's 18 savings banks, including some that have been involved in recent mergers, have failed tests to see how they would cope with worsened economic conditions.

PHYSICAL GOLD DEMAND SOFTENS

Among other commodities, oil prices eased from an 11-week high to near $79 amid uncertainty over the stress tests, while copper prices rose.

On the physical gold markets, buyers in India, the world's largest bullion consumer last year, stayed away for a second day in anticipation of further price falls.

Meanwhile holdings of the world's largest gold-backed exchange-traded fund, New York's SPDR Gold Trust, fell more than 6 tonnes to a six-week low of 1,302.046 tonnes on Thursday.

Demand for physical gold investment products like ETFs, coins and bars has softened as concerns over financial market stability have receded, analysts said.

Longer term, more upside is still seen in the precious metal. Swiss bank UBS revised up its 2010 gold price forecast to $1,205 an ounce from $1,129 on Friday, and its 2011 price view to $1,295 from $1,250.

We believe that ongoing pressure on sovereign debt markets, combined with persistent concern over private sector credit contraction will raise the specter of debt monetization repeatedly over the next few years, the bank said in a note.

A Reuters poll of 55 analysts, traders and fund managers released earlier this week showed an average forecast of $1,197 an ounce in 2010, rising to $1,228 next year.

Among other precious metals, silver was at $18.16 an ounce against $18.07, platinum was at $1,538 an ounce versus $1,521.10, and palladium at $456.53 against $454.

(Reporting by Jan Harvey; Editing by Sue Thomas)

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