Gold rose nearly 2 percent to $1,217.60 an ounce in Europe on Tuesday after a ratings agency downgrade of Portugal knocked the euro, boosting the metal's appeal as a hedge against currency market volatility.

Although the single currency later pared losses after a well-received Greek treasury bill auction, its fragility in the face of bad news from the euro zone has kept the market on edge.

Spot gold was bid at $1,215.85 an ounce at 1310 GMT, against $1,194.85 late in New York on Monday. U.S. gold futures for August delivery firmed $18.00 an ounce to $1,216.70.

The downgrade reminded people that Europe is not really in a good way, said Commerzbank senior trader Michael Kempinski. Gold needs to break $1,225/1,230, then it will be more interesting. So far (it is) still stuck in a range here.

The euro fell broadly in early trade after ratings agency Moody's downgraded Portugal's debt rating by two notches to A1 with a stable outlook, exacerbating concerns over peripheral euro zone debt.

Concern over euro zone sovereign debt levels drove gold to a record $1,264.90 an ounce in June, but prices receded after a successful Spanish bond auction and after a one-year European Central Bank liquidity scheme expired uneventfully.

The market remains sensitive to such concerns, however.

What we see from our clients is that there is a lot of interest in protecting portfolios, and exposure to gold at least dampens down some of the worst effects of currency volatility, said Daniel Smith, an analyst at Standard Chartered.

There is a continued focus in Asia as well on worries about inflation, he added. It still very much remains a tale of two worlds, which is that the West is still very worried about currency values, and Asia is worried about potential inflation. Both of those things are supportive for gold.

The euro has pared some of the hefty losses it made against the dollar earlier this year, but remains down some 12 percent from the end of 2009.

GFMS SEES BIS SWAP AS POSITIVE

Among other commodities, oil rose above $76 a barrel as optimism about the economic recovery offset a report predicting oil demand growth will slow next year, leaving the market well supplied. Base metals mostly turned higher.

Elsewhere, GFMS chairman Philip Klapwijk told Reuters Television the 346 metric tones of gold swap operations by the Bank of International Settlements in recent months highlight gold's central role in the world financial system.

The operations are unlikely to lead to dumping of the metal on the market, he said. The operations, detailed in the latest BIS annual report, show the bank was holding 346 metric tones of gold as part of swap operations in exchange for currencies.

Here we have gold being used quite creatively, Klapwijk said. That is in a sense a validation again of gold's centrality to the financial system.

Appetite for gold-backed exchange-traded funds recovered, with holdings of the largest, New York's SPDR Gold Trust, edging up 0.304 metric tones on Monday after they declined more than 4 metric tones last week.

But gold demand in India weakened as traders sought lower prices to execute deals ahead of the festive season, with a softer rupee, which makes the dollar-priced metal more expensive for local buyers, also weighing on sentiment, dealers said.

Among other precious metals, silver was at $18.25 an ounce versus $17.86, platinum at $1,520.50 an ounce against $1,512, and palladium at $458 against $452.

(Reporting by Jan Harvey; Editing by Anthony Barker)

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