Why Investors Should Always Hold a Position in GoldBy Nicolas Mathier, Founder, Global Precious Metals
Published on March 20, 2020
The financial system is fraught with counterparty risks which are constantly being tested amid instability, political changes, and threats to our global economy that trickle down from pandemic-hit China; a shift in political ideology towards nationalism causing events like Brexit; potential nuclear proliferation in Iran; or even polarised upcoming United States presidential elections.
The gradual rise in the price of gold over the past decade, and more so its spike in the last two years, is a testament not only to its unhindered store of value and demand over centuries, but also that it is indeed a safe haven in economically troubled times. Continued interest in gold, levels of reserves held by central banks, and volumes that continue to be traded indicate that investors understand the asset’s value; the interest in owning gold as a tangible liquid asset outside of the financial system goes further as a hedge against counterparty risks, failures of which we have seen too many of in recent times.
While markets have bounced back since the last financial crisis, there has been an air of caution and global debt has nevertheless increased, which in part explains the continued appetite for gold as a reliable asset that governments cannot expropriate, and which financial institutions cannot use in their fragile fractional reserve banking systems. These factors further explain why the price of gold has been maintained, if not strengthened. While the price volatility of gold in the short term is reactionary, time has shown that it is also a combination of events that has resulted in a gradual market correction.
– Voltaire, 1972
Outside of price-influenced buyers of gold, there are a significant number of investors in the precious metal who are all too aware of counterparty risks, and regardless of gold’s performance, are fully invested in the characteristics of physical gold and in maintaining a position outside the banking system. Precious metals stand out in the investment universe because they are no one’s liability and have no counterparty. Financial institutions are highly leveraged to the point that the failure of a significant player would result in a systemic collapse. The term “too big to fail” has been coined to reflect this reality. Banks and other financial institutions are holding record amounts of derivatives and structured products for which value and liquidity are not understood in times of extreme events; at times during major global or local financial distress, gold exchange-traded funds (gold ETFs) and the paper gold exposures move in different ways due to the counterparty risks within those structures. To add to this, major global institutions have been perpetrating frauds and market manipulating markets, which put at risk investors’ holdings and further subject the institutions to dramatic fines and significant losses. In these days of unprecedented financial experiments, many investors choose to diversify part of their portfolio by adding physical precious metals.
At Global Precious Metals, client holdings are fully segregated, so they have distinct and full legal ownership and their assets are devoid of systemic financial sector risk. As gold is a very liquid asset, it can be traded rapidly in large volumes on transparent markets, with no conditions or caveats attached. Having a hard asset that has stood the test of time over centuries, and that is accessible 24 hours a day is of great appeal to HNW clients. Another appeal of physical gold is its confidentiality, and the fact that it also sits outside regulatory proliferation that has been spilling out incessantly in recent years, inhibiting autonomy over one’s assets.
There are significant differences between paper gold such as derivatives, unallocated accounts and ETFs, and holding physical gold. Primarily, the benefits derived from holding physical gold, which is a tangible hard asset to which an investor has legal title, is the ability to hold it at home or in a vault with unfettered access. This is not available for ETFs, which are essentially IOUs to be settled in fiat currency. To add to this, custodians of the gold backing the ETFs can use undisclosed sub-custodians holding the bullion in undisclosed locations, and there are several limitations to the liability of the custodian and sub-custodians. If an investor owns an ETF, he does not own gold – he owns equity in a fund that owns gold and related derivatives; If an investor owns a derivative, he does not own gold, he owns exposure to a contract which may or may not be settled sometime in the future.
Most of the world’s gold is held in unallocated accounts provided by financial institutions and large bullion dealers. While such accounts are described as the most convenient, cheapest, and easiest ways to gain exposure to bullion, specific bars are not set aside for the client and the account is backed by the credit worthiness of the institution. The London Bullion Market Association clearly says that with such accounts, “the client is an unsecured creditor”. The reality behind these accounts is that they are an investment structure whereby the investor provides free capital to the supplier (and sometimes pays a small fee in the form of margin to do so) and risks the loss of his capital should the supplier become insolvent. As an investor in unallocated gold, your metal is on the balance sheet of the supplier as a liability and you remain exposed to its insolvency; the actual metal doesn’t necessarily need to exist, pursuant to the terms and conditions of the unallocated storage contract.
Accordingly, the principal difference is that physical gold is owned directly by an investor, whereas paper gold belongs to third parties that have a relationship with the investor through shares or a contract, and physical delivery of the gold-backed paper is contingent upon the terms of the contract, which is usually unavailable to the investor or too costly.
When a client wishes to invest in physical gold, we advise them to consider the following key components:
- Storage in a stable jurisdiction known for efficient commercial law and property rights enforcement.
- Bullion, logistics, and storage offered by a reputable provider, preferably being part of a reputable group of companies and with the directors clearly identified and accountable.
- Full insurance coverage up to the replacement value of the metal, at no additional cost.
- Documentation clearly evidencing the title in the property by the investor (usually accomplished with a sale invoice by the company, complemented by a warehouse receipt and a certificate of ownership) to reinforce the fact that the ownership lies with the investor.
- A storage agreement that clearly limits what the supplier can do with the investor’s metal and outlines his role as a mere service provider.
- Documentation and statements setting forth the exact weight, manufacturer, fineness, and bar number of your property. Failure to do this by the provider means that you are involved in an unallocated storage scheme.
- Regular audits by independent third-party auditors.
- Competitive storage and administrative fees, which should not exceed 1% of the value of the metal per annum and should be closer to half a percent (including insurance).
- Ability to sell your holdings back to the supplier in a convenient and fast way.
- Ability to pick up or inspect your bullion at the storage facility with minimum notice to the provider (48 hours maximum).
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