* Gold extends retreat from record as risk appetite rises

* Scrap supply dwindling could further boost gold rally

* Largest gold ETF sees largest outflow since late January (Recasts, updates quotes, adds double byline, adds double dateline, previous LONDON)

By Frank Tang and Jan Harvey

NEW YORK/LONDON, (Reuters) - Gold dropped 2 percent Friday, extending the previous session's drop from record highs as a rise in appetite for market risk prompted profit-taking from bullion's sharp safe-haven rally this week.

Bullion fell as stock markets in Europe rallied after a ban on short selling financial shares tempted investors back. Wall Street equities rose over 1 percent as mildly upbeat retail sales data offset a weak reading on consumer sentiment.

Despite Friday's decline, gold is poised to rise more than 4 percent this week, its biggest weekly gain since early November, while the S&P 500 is set to fall for a third straight week on double-dip recession fears. The metal has gained as much as 13 percent in the last two weeks.

"Near term, a correction makes sense in relation to other safe havens," said Macquarie analyst Hayden Atkins.

Spot gold fetched $1,730.19 an ounce at 11:24 a.m. EDT, hitting a session low of $1,722.94. It has risen 22 percent so far this year on a potent mix of concerns over U.S. and euro zone government debt levels and economic growth.

US gold futures for December delivery were down $18.50 at $1,733 an ounce.

The Dow Jones industrials were up 1.5 percent around midday after U.S. government data showed retail sales posted its biggest gains in three months, while consumer sentiment worsened sharply in August.

The rebound in stock markets since Wednesday's slide has diverted money from gold, which at one point was up as much as $150 this week, hitting a record $1,813.79 early Thursday.

"While we believe that macro-economic uncertainty will sustain the secular bull trend in gold, the velocity of the recent move higher also opens the door to a steep if temporary downward correction," Katherine Spector, commodities analyst at CIBC wrote in a note.

Spector added that CME Group's margins hike earlier this week could also put a short-term brake on gold's rally.

The CBOE Gold ETF Volatility Index, which is often referred to as the "Gold VIX" and is based on SPDR Gold Trust options, is on track for its biggest one-day drop since November following a spike earlier this week amid a global market meltdown. (Editing by Alden Bentley)