Gold on the Comex division of the New York Mercantile Exchange rallied on Tuesday as fighting on the Korean peninsula and uneasiness over the European sovereign debt situation prompted investors to avoid riskier assets despite a stronger dollar environment.

Gold futures for December delivery were recently up $20.40 or 1.5 percent at $1,378.20 per ounce.

"Gold is rallying due to the unexpected flare-up near the North and South Korean border," a US-based gold trader said.

“When people woke up in New York this morning they saw those stunning images of black smoke bellowing up from that small island,” he added. “It's the worst bombing since the end of the Korean War so there's a legitimate fear that things could escalate.”

North Korea bombed the South Korean island of Yeonpyeong with artillery shells near a disputed western border, killing at least two soldiers. The North Koreans attacked after warning the South to halt military drills in the area.

Based largely on Asian instability, the Dow Jones Industrial average dropped sharply and was recently trading down 140 points or 1.25 percent at 11,038.

Additionally, the European sovereign credit crisis appears to be migrating from Ireland to the continent, which has investors fleeing the euro.

The spread that Spain and Portugal must pay on 10-year debt compared to Germany moved to a new high early this week. There is now a growing sense that other counties might soon ask for their own bailout package.

"Gold likes a crisis and you have plenty of them to pick from today - $1,400 is back in play until this geopolitical and economic tension dissipates," the trader said.

Based on the worries out of Europe, the dollar jumped 1.5 percent to hit 1.3412 against the euro. The greenback was also boosted by a positive revision in the third-quarter US GDP to a 2.5 percent annual rate from two percent.

Nevertheless, the weaker euro did little to dampen gold's momentum.

"In a vacuum, the Fed's quantitative easing (QE2) programme would have led to a weaker dollar but hasn't happened because there are these other messes around the world," a second New York-based gold trader said.

"The dollar has suddenly become the best of the worst currencies when you factor in the sovereign debt crisis, the political uncertainty in Korea and China's posturing that it wants to slow down growth," he added.


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