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Worldwide economic uncertainty has
created a growing interest in precious metals as a way to preserve wealth.
Today, global risks for investors include currency devaluation, sovereign
debt defaults, bond market collapses and stock market losses, all underpinned
by ever-increasing government debt.
For protection from impending
economic Armageddon, investors are turning in increasing numbers to the
traditional safe haven of precious metals. Unfortunately, many today don't
know how to purchase or store bullion, and consequently may find themselves
as vulnerable to financial collapse as those who didn't purchase any bullion
at all.
This increased interest in precious
metals as portfolio insurance has spawned a new generation of precious
metals-based financial products, many of which are paper proxies or
derivatives of bullion. There are even unregulated markets for the exchange
of "digital gold."
A clear case for transparency
In 2007, former Bank of Canada
Governor David Dodge gave a speech entitled "A Clear Case for
Transparency" to the Canada-UK Chamber of Commerce.
"...[I]investors will have to take on more responsibility for diligent
research," he said, "so that they can better understand the nature
of their investments and demand greater transparency where it is now lacking
... they must do their own homework and make a concerted effort to understand
what they are buying."
Most investors do not read the fine
print of the agreements they sign with respect to financial investments; they
make assumptions, but do not definitively know if they own actual bullion.
Some are attracted to certain bullion investments because of low premiums and
low storage fees, but when was the last time Wall Street and the major banks
gave the investing public a deal?
Investors who don't do their homework
may be dismayed to find that their safe haven asset has proved to be anything
but. These same people perform rigorous due diligence when purchasing a home,
car or boat, demanding that they have clear legal title to the asset in question.
The same attention to detail must be paid when investing in bullion.
The most important concept to
understand is that a financial institution CAN sell an investor's bullion if
the agreement states that it can. Banks are not raiding allocated accounts; rather,
they are following the provisions of the contract, in which the bullion is
not allocated despite an investor's assumptions.
There does appear to be cause for
concern regarding the transparency of bullion products. As reported by the
economic news website ZeroHedge, financial services
giant Morgan Stanley paid out $4.4 million in June 2007 to settle a class
action lawsuit brought by clients after the firm charged them to "buy
and store" precious metals, but did neither .
Similarly, a class action lawsuit
filed in New York's federal court accuses UBS Financial Services of
misleading silver investors, and charging them storage fees for metals that
were never purchased, let alone allocated or stored for them.
A larger problem has been brewing for
several years now, that of exchange-traded funds (ETFs). These are generally
viewed as a low-cost panacea that replaces almost any investment strategy,
including the purchase of gold bullion, and they are giving investors a false
sense of security.
False sense of security for ETF investors
ETFs started as equity index
vehicles, in which brokers acting as Authorized Participants borrowed shares
from institutions, hedge funds, mutual funds or their clients' margin
accounts to contribute to the Origination Basket of shares. They received ETF
shares at Net Asset Value (NAV) in exchange, and sold them to investors at
NAV - keeping all of the money. This is standard practice, as brokers have
always been able to borrow shares from clients' margin accounts for the
purpose of shorting or for lending to other brokers.
Essentially, many ETFs hold assets
that have been borrowed. Because there are no specific prohibitions to
prevent the same practice from being used in precious metals ETFs, the same
methodology is likely being used. Many investors are attracted by the low
management fees offered by precious metals ETFs, but few understand the
problems that may arise when more than one person has claim to the same
asset.
ETF-based financial crisis could make 2008 look like child's play
This ETF structure will work during
normal market conditions. However, it may result in losses and disputes if
the Authorized Participants, acting as market makers, become insolvent or
step aside during a precipitous decline. If a bank or brokerage firm becomes
an insolvent Authorized Participant, either the lender of the assets or the
ETF shareholders will suffer losses. During a market crash, existing holders
may be unable to sell their ETF shares. Although this possibility was
considered remote when ETFs were created, the recent and recurring failures
of banks and brokerage firms make these concerns far more real
.
The bottom line on ETFs is that they
are tracking vehicles with multiple claims/counterparty risks on their assets
as well as their shares. As debt-based stress on the global financial system
continues to build, the flash-crash of 2010 may well have foreshadowed an
ETF-based financial crisis that will make the subprime mortgage crisis of
2008 look like child's play.
Own bullion with clear title
When we at Bullion Management Group
sit down with clients seeking to own bullion, we present them with our
Precious Metals Pyramid Chart. Moving up the pyramid increases risk; moving
down the pyramid increases safety. A portfolio's foundation should consist of
physical bullion owned outright. Farther up the pyramid are proxies of
bullion in one form or another that are more risky and often less liquid; in
other words, the opposite of a safe haven asset you can count on in times of
financial stress. Bullion should always meet two criteria: It should not be
someone else's liability, and it should not be someone else's promise of
performance.
To establish a physical bullion
portfolio foundation with metals that are stored on an allocated and insured
basis, one that will protect against what could be called ethical mayhem in
today's financial sector, investors must, as Governor Dodge advised, make a
concerted effort to understand what they are buying. While reading legal
documents and prospectuses is tedious, the truth is in the fine print and
investors must do their own due diligence, and beware of complex investment
structures.
Demand documentation that transfers title directly to the purchaser
For a bullion product, be it a fund
or actual bullion bars, to earn its place as the foundation of a portfolio, the
bullion purchaser must demand documentation that legally transfers title of
specific, physical bars directly to them. Do not accept IOUs, paper proxies
or derivatives. It is important to read the purchase documents carefully to
ensure they convey legal title. Only after the purchaser has legal title can
they enter into a binding custody agreement for bullion storage on an
allocated, insured basis. In that agreement, the purchaser must be able to
identify all terms and rights concerning insurance and secure,
allocated storage.
Proper insurance and allocated
storage in a credible, guarded vault costs money, so steer clear of bullion
products promising low fees. If the deal appears too good to be true, the
physical bullion may not exist. What the investor may have is paper bullion
that will not offer protection when it is most needed; they may simply be an
unsecured creditor of the dealer. It is hardly prudent to be tempted by low
storage fees that will save a fraction of a percentage point while risking an
entire bullion holding. Short cuts and penny pinching are inadvisable
strategies for any asset intended as an ultimate safe haven of wealth
protection.
Home storage not worth the risk of invasion or physical assault
Many people think that storing their
bullion at home is a good way to economize on physical bullion storage fees,
but be aware that any sizable amount of home-stored bullion will not be
covered by a household insurance policy.
Keeping a modest--and secret--stash
of small-denomination gold or silver for barter purposes is recommended in
the event that ATM machines aren't working, or a 'bank holiday' is announced.
This may seem like an excess of caution until you consider that, earlier this
year, the Bank of Italy authorized the suspension of payments by Bank Network
Investments Spa (BNI) without first advising depositors .
Unless absolute secrecy is
maintained, home storage means putting yourself and your family at risk of a
home invasion. There has been an increase of home invasions in England during
Asian wedding season, when gold gifts are stored in homes, and street gangs
and professional thieves are only too happy to relieve people of their
precious metals .
Even in peace-loving Canada, a
British Columbia man lost his life savings of $750,000 in silver bars to
knife-and-gun wielding thugs who arrived at his door disguised as police
officers. When he let them in, the 'officers' forced him to open his vault
and stole the silver . For any sizable amount of
bullion, home storage is clearly not worth the risk.
Many precious metals dealers do not
trust banks for storage, and prefer private vault facilities. They may
rethink this approach on reviewing a British case where authorities raided
three private safe deposit box centres, and opened
6,717 private boxes . The owners of the boxes were
required to provide proof of the contents of their box before their
possessions were returned. Most could not do so, and much of the cash
involved went missing while other items are in dispute. The ensuing
litigation will likely last for decades; in the meantime, those who stored
bullion in their boxes have been relieved of their metal, and may only
receive compensation in the amount of the value of the bullion at the time of
the raid.
Another consideration is that safe
deposit box contents cannot be insured, and there is no proof that anything
is actually in the box. Investors who are still interested in private vaults
or safe deposit box centres should perform due
diligence on the financial condition of the operator and the owner of the
vault, since stored assets may be at risk in the case of a private vault's
insolvency.
Storing bullion at home, in a safe
deposit box or in a private vault is another form of false economy, wherein
investors put their safe haven asset at risk to save a small amount in
storage fees.
LBMA bullion in LBMA member vaults
Another important aspect of due
diligence for a proper foundation of wealth preservation is the assurance
that your bullion is in the form of Good Delivery bars, and stored in the
vault of a London Bullion Market Association (LBMA) member.
The LBMA is a wholesale,
over-the-counter market for trading gold and silver. Its members include the
majority of the bullion banks that hold gold, plus producers, refiners,
fabricators and other traders throughout the world.
The reason for insisting on LBMA
bullion is that it assures the purchaser of the quality and fineness of the
bars. Once gold is outside a chain of integrity such as that of the LBMA, it
may need to be re-assayed before it can be sold. This prevents gold-plated
Tungsten bars from entering the chain of integrity. Re-assaying is time
consuming, engenders extra cost and once again defeats the purpose of a safe
haven store of wealth that offers efficient liquidity.
We constantly hear stories of
discount bullion, or bullion sold at no premium to the spot price. The
likelihood that this is pure bullion from an ethical source is slight to
none.
In case of fire, you need an extinguisher, not a picture of one
Bullion demand is clearly growing as
both sovereign nations and the world's largest financial institutions buckle
under the burden of unserviceable debt, leaving helicopter-loads of new money
printing and associated currency devaluation as the only way out.
Investors can protect their
portfolios by purchasing physical bullion. Just as with any large asset
purchase, demand documentation that confers legal title to the bullion you
are purchasing, review a written custodial agreement that specifies insured,
allocated storage without giving the custodian the right to deal with the
bullion in any way, and insist on Good Delivery bars.
When the next financial firestorm
erupts, you need real, physical bullion and not a paper proxy; just as in a
fire you need a real fire extinguisher, not a picture of one.
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