The contentious drop in gold prices is parallel to so many other assets at the moment that it cannot be anything but a liquidity event. At this point, the proximate cause is really academic; Bank of Japan, China, taper, etc. However, despite protestations, and vehement at that, that the euro crisis has been buried, the opposite is again becoming reality.

The problem of the euro has been about fragmentation. Liquidity is plentiful only in specific regions. There were re-assurances after Cyprus that the Eurosystem would withstand any short-term volatility that might result from the growing temptation to "bail-in". But what has happened in the interim speaks to growing wariness to those ends.

First, the Wall Street Journal reported that current European negotiations on the terms of bail-out vs. bail-in had cleaved along the lines of the north/south divide yet again.

But to the dismay of the commission, which is seeking a uniform regime across the bloc, several governments also want to be able to exercise discretion over which liabilities would be excluded from losses when a bank fails. According to officials involved in the negotiations, they are likely to win.

Think about the implications of such country-specific rules and regulations. If Germany, for example, is allowed to set separate rules for its banks than Spain, it opens the door to removal of banking capacity also along those lines. As Germany retains the right to bail-out at its own discretion, banks have incentive to become "German" in some way, shape or form. What is left in Spain are those that are stuck with "bail in", and likely through no choice of their own.

In terms of wholesale liquidity, the ECB is lobbying to exempt interbank deposits from the bail-in list. The reason is further and deepening fragmentation, a problem that played a primary role in the ECB's decision to narrow its interest rate corridor last month. Further, I suggested before the rate corridor decision that Draghi and the ECB were reacting to funding conditions in the wake of Cyprus precisely on fears that fragmentation would not only persist, but deepen. Liquidity in Europe cannot be anything but problematic under fragmented conditions.

It turns out that seems to be what happened, but not exactly in the manner I had surmised at the time. It wasn't retail deposits that moved from south to north (or out to Switzerland) as they had entering the summer of 2012. Instead, it is interbank deposits growing only national in nature. The Eurosystem continues to break down as banks stop cross-border funding, yet hardly anyone seems aware or to care.

According to Reuters (via LiveMint WSJ),

In a trend that could reignite fears about the euro and its banks, European Central Bank (ECB) data shows the share of interbank funding that crosses borders within the euro zone dropped by a third, to just 22.5% in April from 34.5% at the beginning of 2008.

Cross border funding is back to where it was when the euro was first adopted in 1999. They note that interbank funding to Greece was 68% below April 2012, while down 25% in Portugal.

As is usual, the ECB offered its obligatory and worthless denial, reassuring us that, "Overall these facts suggest rather a stronger, more resilient banking system." In the real world where hope and misdirection is not a viable strategy, the breakdown of interbank funding leaves the European system without a reliable liquidity buffer. In fact, that has been the entire thrust of the ECB's banking programs - to re-establish that liquidity buffer (which would have denoted a stronger, more resilient banking system).

In short, history rhymes. While it was retail depositors in 2012, interbank depositors are not sticking around the periphery to see how bail-out vs. bail-in shakes out. For "core" banks, it is far better to keep their euros at home and deal with the devils (regulators) they know are going to go to bat for them. It's a rerun of 2012 in so many respects, particularly that central banks cannot solve the flow aspects to liquidity (liquidity is far more than just money stock, it also requires effective flow).

The rather obvious difference between 2012 and 2013 is the striking backdrop of global volatility in the wake of central bank extremis. The Bank of Japan proved it was willing to destroy the yen while the Federal Reserve simply raised the "minor" possibility that asset bubbles were back. Brazil lurches in currency crisis, as is India.

Gold should be drastically bid, as there is no more favorable environment for gold than currency instability on such an unseen scale. But we have to remember that gold is also a slave to financial reality as long as it remains a minor incorporation in modern global banking collateral management. That means that as long as liquidity pressures dominate the rather wide margins of the contours of the banking system, it will be on offer. All that matters in a world where the dollar is the reserve currency is the massive and synthetic dollar short.

Just as we have seen before, liquidity shortages are short and intermediate "bad" for gold. The flipside is the instability should eventually reverse that track, but it is absolutely impossible to know when or where that might occur.

Suffice to say, corresponding volatility in gold, bonds, and currencies is not a sign of "normalcy".