Well sure you can install Windows XP Mode onto an external. The whole point of Virtual PC is it emulates a standard PC, in fact this very one from 1998:
American Megatrends (AMI) BIOS
Intel Pentium II on 440BX chipset
S3 Trio 32 PCI GPU with 4 MB video RAM
Creative Labs Sound Blaster 16 ISA PnP
DEC 21041 or 21140 10baseT Ethernet network card.
As standard as you can get! Needless to say, performance is intended more to be compatible than good, and programs that attempt to directly access "hardware" will fail, but it's a great way to test if programs work in XP.
Emulating XP on a machine isn't the same as running XP on it, but you will still have to install XP to run on the above simulated machine after formatting its virtual hard disk. Of course you first have to install Virtual PC to your internal drive, plus launch it when the external is plugged in and powered on.