The events of the last several days were nothing short of extraordinary. As the political viability of aggressive austerity plans became even more untenable, the markets cascaded into risk aversion territory unseen since the nadir weeks of 4Q 2008. In the days leading to the massive dislocations of May 6 and May 7, flight to “quality credit” was accompanied by a growing short position in Euro, peaking at some $17bn. All along, gold kept inching up, losing only two days over 13 sessions. The ETF positions grew to a record, the speculative Comex long shot up, coins and bar sales picked up strongly in Germany and in the US. Imports to India remained strong ahead of the upcoming Akshaya Tritya festival, to be held on May 16.

But then an equally extraordinary realization kicks in. Gold has resumed its risk aversion function, but from a perspective of a different currency. Euro woes and Euro depreciation lead to stronger flows in gold, undermining a decade-long dogma about the relationship between the dollar and gold. In fact, in the dramatic hours and minutes of the May 6th market “glitch”, gold benefited in synch with the other areas of refuge: the liquidity of the US Treasury market, the credibility of the German Bund and the risk aversion of capital repatriated by the Japanese investors back into the Yen space. For several trading days it seemed like the UK gilts could join this rarified company, but the inconclusive election and the prospects of a new man on Downing Street discovering something “Greek” about the British books have stalled any further interest in the UK debt.

The Magnificent Four were all aligned to accept inflows from various sources of capital, with only the German Bund investors “trapped” in the Euro area – with losses offset by the unprecedented compression in yields – from 3.4% to 2.8% within several weeks. Against the backdrop of street clashes in Greece and the Shanghai market entering a bear territory, an academic could ponder on the relative merits of the four safe heavens.

The arguments in favor of Yen assets are well known – the gross debt to GDP is double the size of Japan’s net debt to GDP and the government’s financial assets equal roughly the outstanding bond value of JPY 551 trillion. Importantly for the holders of Japanese debt (only 7% of which is held overseas), the BOJ has a rule not to hold more JGB than total banknotes in circulation and thus it cannot monetize government debt. There is, therefore, some merit in parking capital in a developed economy with what is nominally the largest debt burden on the public balance sheet.

The Bund’s attractiveness even increased with the political censure meted out to Berlin’s politicians for their perceived largesse towards those “verschwenderisch” Greeks. And although federal accounts do not quite meet the Maastricht treaty, Germany remains an oasis of fiscal conservatism even after the 2008 tax cuts and 2009 stimulus package. However, the situation in the Länder and municipalities is much less rosy. Large sections of the German public are tired of financing re-unifications, EU enlargements and now bail-outs. Their quest for gold coins is understandable, but hedged for currency effects, the Bund remains a defensive investment par excellence.

The US Treasury market has stabilized without major hitches, following the successful phase-out of QE. Interestingly, the increased tax receipts in the recovering economy will now lead to a reduced supply of new Treasuries, with concomitant pressure on the yields. The attractiveness of these products lies invariably in the size and the depth of its pool. Unfortunately, the wall of money running into the dollar space will push down the lending costs in the US, recreating some of the conditions which led to the financial crisis in the first place. At the same time, by bidding up the dollar, the inflows will make it harder for the US industry to compete in the global markets.

This leaves us with gold. The most interesting day came for gold after EU leaders announced the $1 trillion package to soothe the markets. In the early Asian hours on Monday, gold retraced considerably. However, it was the ECB’s unprecedented announcement of the future expansion of its balance sheet to “purchase malfunctioning securities” that switched gold traders’ focus from Mediterranean austerity woes to potential inflationary effects of the joint EU/ECB intervention. Should ECB fail to successfully sterilize the purchase of the less palatable products, the liquidity conditions in the global market could be affected as in 2009. In the late trading on Monday, Euro stabilized and gold resumed its climb.

The optimism has not lasted for long, the Euro has now weakened again, Chinese inflation chill continued to spread and gold has notched its 20th all time high in Euro in some 60 trading days and shortly after that an all time high in US dollars as well. We are now entering a serious currency crisis and the risks that a sequel could unfold any day – in Euro or in the British Pound. For now, the Magnificent Four are on the march again… Which of them will fail first?

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Tags: ECB sterilization, ECB's QE, gold and currency crisis, gold at all tiime high, Treasuries and gold