Debt restructuring anyone? Of some 300bn Euro worth of Greek bond holdings, most exposure is concentrated among holders in the UK, Ireland, France and the German speaking economies. As much as 5% of Irish bank assets are exposed to what is now commonly considered toxic waste. In Belgium, Spain and – importantly – in Germany, the exposure nears 3%. This clearly isn’t just a “Greek problem”.

The political unpopularity of the bailout has made the motley EU-crew’s decision-making tortuous and ultimately dangerous for scalding costs of servicing Greek paper. No wonder that the structurally overvalued Euro began to experience irresistible gravity since early December. The seemingly open-ended character of the Greek crisis and the uncertainty of the end-game have exposed the common currency to headwinds redolent of the infant Euro early this century. Meanwhile, China’s ravenous appetite for dollar-denominated materials swamped its unexpectedly poor export data and wiped out the mercantilist economy’s trade surplus in the first quarter. As a result, Euro could not even count on the blip in the form of PBOC/SAFE unloading of surplus dollars – which used to accompany increased renminbi sterilization momentum and usually correlated positively with Euro’s strength.

This should have been a nightmare scenario for gold. But it is not.

Over the last two months (42 trading days), USD gold appreciated on 24 days, five more than the EUR-USD pair. Early this week, gold gained 1.3%, even though Euro slid further 0.7%. On average, gold outperformed Euro by 0.16% daily. Gold’s amazing resilience seems to bear out the hypothesis of a somewhat asymmetric relationship between the Euro and (the dollar-denominated) gold. While a strong Euro usually bolsters the gold prices, a weak Euro does not damage the yellow metal. Of the four worst gold days during the same period, one of the pullbacks was registered on a strong Euro day. It could be that recurrent profit taking is responsible for these fluctuations, although such behavior has only been document in Japan, were 27-year high prices have this month enticed many holders to realize their yen profits en masse.

Yet the Euro’s 3% loss to the dollar over the same period overstates the level of dollar’s strength. The trade-weighted DXY dollar index has appreciated by 2.4%. This gap is already closing. The draconian changes to the regulations governing China’s residential real estate have already depressed the value of mainland-exposed realtors in Shanghai, Hong Kong and Singapore. The fall of this index has historically been a good leading indicator of turns in industrial commodity prices and eventually in commodity currencies. As a consequence, DXY could strengthen even further, especially if the US administration continues to sail forth on the recent sense of mission. Would broader dollar strength spell trouble for gold?

Not necessarily. Even if DXY has appreciated 2.4%, gold in USD outperformed it by another 1.25%. This arguably pales to the run enjoyed by gold-exposed Euro investors, who have seen the value of “their” bullion jump by 5.38% in the last forty two days. More importantly, the momentum for Euro-denominated investors is strengthening amidst fluctuating EUR-gold correlation. The momentum for USD-denominated prices has ebbed, although not to the point to trigger “Japanese”-style selling behavior.

All this points to further Euro woes down the road and the absolute necessity to protect European private wealth from further erosion. Looking for further domino pieces, some observers are pointing towards Portugal’s high levels of private debt and the country’s uncompetitive private sector. Not surprisingly, the country’s 2-yr yields jumped over 20% within just one trading day this week. As usually, the rating agencies reacted belatedly. As even tiny Slovakia has to buck up to bail out the crumbling Colossus of Rhodes, the willingness to provide further succor to profligate neighbors may be running thinner by the day.

Athens has pledged to raise taxes, which in normal circumstances is deflationary – unless introduced against the background of severe deficits. The weakening Euro could go some way to alleviate the pressure on Mediterranean exporters, provided they are capable of gaining market share outside of the Eurozone, and especially in the key emerging markets. Such renaissance of global competitiveness seems all but guaranteed and we now may be trapped in recurrent Euro-scares, regardless of periodic bailout efforts. Pity the bondholders who sooner or later will have to face debt restructuring. Meanwhile, any sources of physical gold demand, whether Indian, East Asian or Western, will reflect more strongly in Euro terms than in US dollars. Since the beginning of the year, gold notched 9 all-time high records in Euro terms. For as long as investors are willing to condone the $0.5bn per day servicing costs of the US public debt (costs which are bound to quadruple this decade), Euro-denominated gold holders will have more fun.

For now.

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Tags: debt restructuring, DXY and Euro, euro gold, Euro gold correlation, Euro weakness, Greece debt and gold