"...Why are wealthy investors
swapping gold futures for physical metal that they own outright...?"
A LITTLE LESS
than 12 months ago, the world's biggest financial players suddenly found they
could not turn some $1.3 trillion of their assets into cash.
These assets - bonds backed by US
home-buyers with low (or no) incomes - had become utterly illiquid. No one
would buy or lend against them, not at any price. And an asset you can't sell
or borrow against is worth precisely nothing.
The resulting mayhem? It would have
sounded frivolous two years ago. But the subprime
crisis caused the first run on a
British bank run in 130 years, a forced collapse in US interest rates, and
the fire-sale of Wall Street's fifth largest investment bank for just
16¢ on the dollar.
"[Now] it seems that the financial
system is slowly working its way through this subprime
shock," writes Gillian Tett in the Financial
Times. "The largest banks and institutions have written off almost
$200 billion and raised more than $100bn-odd of
capital to plug this gap.
"Indeed, the write-downs have been
so vast that some analysts expect to see some write ups in the next set of
Crisis over? That key marker of investor
anxiety, the Gold Price, fell 15% from
its top of mid-March to the end of April. The preceding surge had taken gold
bullion up from $650 per ounce in August to above $1,030 the day after Bear
Stearns was sold to J.P.Morgan.
The proximate cause
for gold's jump - and then setback - was the Federal Reserve's decision to
slash US interest rates. Gold turned sharply higher as the Fed began
cutting rates in Aug. '07. It only flagged when Fed policy-makers implied a pause in their war against the Dollar (albeit it
temporary) seven months later.
Cheap money and the inflation it causes makes gold bullion
an attractive asset. Central bankers can't print it; investment bankers can't
promote it to destruction. But "in addition to being generally positive
for gold prices, the credit crisis brought counterparty risk to the
fore," as Nikos Kavalis of the GFMS consultancy in London reminded us here
by phone this week.
That's why a significant portion of new Gold Investment
since last summer has gone into physical metal - owned outright - rather than
simply into paper promises or credit arrangements.
"In many cases, we've actually seen
investors moving away from positions they already had in place, moving out of
both unallocated accounts and gold derivatives, and into allocated
metal," says Nikos.
"Largely as a result of the crisis
in the credit markets, a number of high net worth individuals have invested
in physical gold."
Unallocated gold is the gold market's
major concession to financial trickery (a.k.a. "innovation"). Merely
a book-entry on a credit ledger, it works much the same as a bank account -
only without deposit insurance - representing a loan from the buyer to the
That leaves the investor very much
"on risk" with regards to the brokerage's financial survival. And
it's been estimated to us here at BullionVault that well over 95% of the world's daily gold dealing is still done
on an "unallocated" basis.
What makes physical bullion stand out
for the growing number of private investors choosing outright ownership
instead? Gold futures or options would, after all, give them leverage to the
gold price, super-charging their gains if they call the short-term direction
But leverage pays nothing if your
counterparty defaults. And for
investors with money to lose, physical gold bullion sits in a much-needed
asset class all of its own.
First, the physical Gold Market
centered in London
is one of the deepest and most liquid capital markets in the world. Turning
bullion into cash is easiest for investors dealing warranted gold bars. Kept
in professional storage to retain maximum resale value, gold held in the form
of these large 400-ounce bars also avoids wide dealing spreads and commission
Repeated studies also prove gold's
safe-haven appeal on the basis of its "non-correlation" with
securitized assets, such as equities and bonds. Gold Prices
move independently of the broader financial markets - neither together, nor
in opposition. This lack of correlation makes gold a crucial component of any
Finally, physical gold bullion -
provided that it is owned outright - is unique amongst tradable assets; because it's almost entirely devoid of counterparty
risk. You'd be surprised how many investors, both private and professional,
fail to realize the difference.
Owning the metal outright - whether as
gold coins in your pocket or large bars held securely in market-approved
storage - takes you "off risk" with regards to the solvency of
banks and brokerages. And it leaves you holding a highly liquid physical
asset that's instantly valued just by checking the Gold Spot Price
"While the subprime
shock may be ebbing," continues Gillian Tett
in the Financial Times, "the problem is that...as the US economy
slows, there is a good chance defaults
will soon emanate from the corporate and consumer debt world.
"And the more that
banks are forced to tighten credit as a result of the subprime mess or
other losses, the greater the risk that this second wave of defaults will emerge - creating the risk of a vicious
The current lull in the Gold Price says fewer
investors are worried today. But only this week, Moody's Investors Service -
one of the three credit-ratings agencies now blamed for letting investment
banks issue toxic subprime bonds as
"triple-A" bonds - warned of a sharp rise in US corporate-bond
failures. It sees the default rate
on low-rated junk bonds quadrupling to 4% by the end of this year.
Wherever the subprime
shock has hit hardest, municipal debt also looks weak. Council members in
Vallejo, California voted on Tuesday to file for bankruptcy, thanks in no
small part to "house prices in Vallejo and the surrounding area falling
some 26% on a year ago," reports The Independent here in London. "The
city is expecting $1.6 million less in property sales taxes."
And all this while - 12 months on from
the first trouble at UBS and Bear Stearns - the final cost of the subprime
shock itself is still pending. Chairman of the Federal Reserve, Ben Bernanke
originally put a $100 billion forecast. The International Monetary Fund (IMF)
has since set the ceiling at $945bn.
But there are hidden costs too, as
Bloomberg reports this week. Now State Street, the world's biggest
institutional fund manager, faces more than $625 million in lawsuit damages,
for instance, after being sued by four insurance companies for putting their
cash into subprime bonds without their approval.
Let's imagine all of your wealth is
sitting safely outside the next subprime-style blow up. A loss of confidence
in one sector can still become a system-wide crisis. And the failure of
subprime bonds to pay up should have reminded us all that counterparty risk
remains very real, no matter how clever derivatives salesmen become.
A growing number of private investors,
in contrast, would rather hold at least some of their wealth in a liquid,
tradable asset, entirely free from the risk of default.
What price they pay should depend on what they think will happen to interest
But the value of Gold as
a portfolio back-stop remains hard to beat, even 15% below the last all-time
high of mid-March
Head of Research
for The Daily Reckoning in London, Adrian Ash is head of
research at www.BullionVault.com
– giving you direct access to investment gold, vaulted
in Zurich, on
$3 spreads and 0.8% dealing fees.
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