Political Metals

If you’ve landed here after reading the Investing in PMs or Holding PMs?, you would have already been cautioned over this.

Should you decide to convert part of your savings in paper currencies into PMs as a hedge against inflation and currency debasement, make sure you land up holding physical gold & silver and not “paper gold” like Gold Certificates, Gold Savings accounts, Pooled gold accounts, Gld or Slv ETFs or anything besides real physical metals with atomic numbers 79 and 47!

Owning physical gold and silver has NO Counter-party Risk. All other PMs financial instruments are merely paper or electronic representations of gold or silver.

There are many ways to own physical metals, but I consider the following two as the most practical options for small to medium holdings.

1. Buy bullion coins & bars and store them yourself. Here are some sources.
2. Buy professional grade bullion from reputable vendors and store them in professional private vaults outside the banking system. You hold gold & silver because you don’t trust fiat currencies and the institutions that issue and manage them. In addition, the time you need your metals most is during a bank run. Hence, a bank’s safe deposit box or bank’s vault is the last place you would store your metals.

Option 1
You buy the metals from a reputable source, take physical possession and store them the best way you can. You have full ownership and custody. There are no third parties involved. Except for theft, you have virtually no risks. This option is ideal for coins and small bars.

Option 2
Due to the relatively high premiums of coins and small bars in many countries, it may be more advantageous to buy and own professional grade bullion bars stored in reputable vaults, especially if your holding is large. It has the added advantage of being much more liquid (easy to immediately sell in large quantities) compared to coins. You may want to apportion your holdings between coins in your own possession and professional bars stored in vaults according to the “Savings” & “Term Deposit” concept discussed here.

This option involves engaging a professional bullion service provider to procure and store the metals on your behalf. If done through an Allocated Account, you have full ownership, but custody is transferred to the third party (vault) through a bailment process. If done through an Unallocated Account, you do not have ownership, merely a claim to the metals. Before opening a bullion account, you need to understand the differences between Allocated and Unallocated accounts and be aware of Counterparty Risks.

Allocated Accounts

When you purchase metals through an allocated account, you obtain and retain title to the metals. Amongst all the metals held on behalf of other clients, your bullion bars or portions thereof are specifically “allocated” to you. You own the metals outright , and your service provider is merely holding it on your behalf as custodians. Under common law, this relationship is known as bailment. Your metals in an allocated account do not form part of your service provider’s assets (not in their balance sheet). In the event of bankruptcy, your service provider’s creditors cannot lay claim on your metals. They belong to you.

Unallocated Accounts (Pooled Accounts)

When you purchase metals through an unallocated account, you do not obtain title to the metals. Units of fine weight of the metals are credited to or debited from your account whenever you buy or sell. The credits in your unallocated account merely represent your service provider’s obligation or promise to deliver your metals upon demand, and do not constitute your ownership of any specific bars or portions thereof. Title to the metals belongs to your service provider and forms part of the provider’s assets (appears in the provider’s balance sheet).

Counterparty Risks

Since owning gold or silver bullion through an unallocated account means that the credits in your account are backed by the inventory (general stock) of your provider, you are exposed to the risk that your provider may not have all the metals they claim to have. In fact, they are not obligated to maintain a 1-to-1 backing for all the metals “owned” by their clients. As is often the case during a crisis, when a large number of the provider’s clients demand physical delivery and there is insufficient metals in the inventory to back all the claims, you may end up loosing your holdings. In the event of bankruptcy, your service provider’s secured creditors will lay claim on their assets first, and you have little chance of claiming your metals because you are an unsecured creditor.

The same applies to banking. The minute you hand a bundle of paper money over the bank’s counter or when you electronically transfer money into your bank account, the title to that money instantly changes hand. It becomes an asset of your bank and in return, they hand you a certificate of deposit or a bank statement evidencing their debt to you. All that amounts to is a promise to pay you back your money at a future date. Again, you become an unsecured creditor of the bank and are now dependent on the bank’s creditworthiness and solvency. All the above risks are known as counterparty risks.

Allocated Bullion Accounts with established and reputable service providers

Back to options (1) and (2) for holding gold and silver.

It’s obvious that option (1) has no counterparty risks. When selectiong option (2), ensure that you open an Allocated Account. In so doing, you have avoided most of the major counterparty risks discussed above. While you are not dependent on the creditworthiness or solvency of your service provider, you are however still subject to a minor risk known as Performance Risk. This is the risk that your provider will not act and do things as they say.

To mitigate this risk, you’ll have to select providers that

• are established & reputable
• have strong governance procedures
• are subject to frequent periodic independent audits
• make such audit reports assessible to you or the general public
• Provides Registered Bars or Segregated Bars

Check out my reviews on three of the more reputable and established service providers, all offering Allocated Accounts.

• GoldMoney - Offers the widest choice of metals(4), currencies(9) & vault locations(3). Great for diversification.
• BullionVault - Great for active trading of gold & silver. Low trading & storage fees.
• Anglo Far East (AFE) - Great for medium to long term storage of gold & silver. Not suitable for trading or short term holding.

To minimise Performance Risk of your service provider, it would be prudent to spread your bullion holdings across various service providers. As you read the reviews, you’ll notice that each has its unique set of features and strengths, all of which are not present in any single provider. Within each provider’s account, request for Registered Bars whenever possible, and further spread your bullion across all vaults.  On top of that, allocate part of your holdings to coins and small bars held close at hand for emergencies.

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